Tuesday, 24 April 2012

A Sign in the Times

This story in the FT sounds like the beginning of the end for the great commodities bubble as insiders seek new capital from greater fools. 

Why would you abandon years of broking commodities and earning a nice little spread in your alpine tax haven for very little risk and start vertically integrating with the mines who take all the risk in some godforsaken desert?

"“We, like others, are looking to invest in the whole supply chain,” said Ian Taylor, chief executive of Vitol, the world’s largest oil trading house."

The reason is a fatal attraction to returns. During an up-cycle the mines make higher ROEs as the price of commodities starts to rise far above the marginal cost of production. As one trading house gets sucked into doing this so do the others in much the same way that Citi’s former Prince Chief said “As long as the music is playing, you’ve got to get up and dance.”

That is quite an apt quote. This is of course absolute folly and exactly the same as happened to the Investment Banks who transmogrifying into mortgage lending behemoths hungry to feed on the excess of profits of the housing bubble era. You stop your riskless broking and start taking risk on your capital because the winnings in the casino look better than the running thereof. However for the managers of these trading houses it's much, much worse. No government is going to consider them of systematic importance so they don’t even get a classy TBTF put option when this blows up.

Now that the worlds dumbest investors (Asian sovereign wealth funds) are getting on board it must be high time to find the exits. With European banks pulling the funding the issue is where is all the cheap cash going to come from to prop up the commodity markets. The issue is not who is going to fund the expansions these guys want to undertake. Perhaps the commodity houses know this too and hence they want to flog some of their shares to these sovereign wealth fools. But this sounds like primary issuance so I guess the commodity houses really do believe the hype in which case the bible actually does have some modern relevance;

"What has been will be again,
what has been done will be done again;
there is nothing new under the sun."
-          Ecclesiastes 1:9

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