Markets slide as trust declines

At the core of the big falls in the global and Australian share markets is a decline in trust. Suddenly investors are nervous that corporations have been hiding bad news to maintain their share prices as illustrated by Volkswagen and Glencore. They don't trust the Chinese economic figures and see the almost 9 per cent decline in profits at China's major industrial companies reported this week as a sign of trouble ahead. And they are wary of the pricing of shares and speculative debt securities at levels which do not sufficiently reflect the risks. Finally they are losing trust in Australia and believe we are headed for much harder times.

I can't tell you where the bottom is in this share market decline (the S&P/ASX200 bounced 2.1 per cent higher today, following yesterday's 3.8 per cent drop, but the index is 16 per cent below its April high) but I know many Eureka Report readers after the fall in shares last month adjusted their equity positions on the recovery to levels where they are comfortable. I thank you for letting me know that you followed my suggestions. 

So let's look at some of these forces. I have been in the company of Glencore chief executive Ivan Glasenberg and he is a wonderful sales person and advocate of his shares. 

London mining analysts are not very sophisticated and have limited knowledge of the minerals market. Glasenberg sold Glencore shares to them to the point where, like him, they were true believers. Some of the more immature London analysts were even sucked into Glencore's line that it should acquire Rio Tinto. So when Glencore shares slumped almost 30 per cent in one day this week it really shattered their confidence in mineral companies, even though there was a partial rebound next day.

Moreover Glencore has $US50 billion of debt of which $US20 billion is short term backing trading positions. The company has always argued that the short-term debt is matched by liquid securities including letters of credit and metal and mineral stocks. And while that might be true in the past Glencore has made mistakes by taking major positions in minerals. 

Last month Glasenberg boasted to the London institutions that Glencore had turned the copper market and I suspect the company has taken a major position in the metal. 

Quite clearly the market is afraid that Glencore is going to collapse and in the process slash the value of all mining assets and the prices of minerals where the company has a major stock position. I am simply not in a position to make a call on the Glencore survival but in any situation like this survival requires a very different management style to that which built up the company. Glencore including its subsidiary Xstrata is based in the idyllic Swiss village of Zug. Not only is it one of the most scenic places on earth but it is also a wonderful tax haven. Managing a company in such surroundings can make you remote from a crisis. Whether Glencore survives or collapses, trust has been broken or at least badly damaged in the sector.

The survival of Volkswagen is not at stake but the company was prepared to lie and cheat to maintain its profitability. Analysts who examined the company's accounts in recent years were simply wasting their time – they were a fiction. Trust in Volkswagen has been shattered but suddenly around the world share investors are concerned that other leading companies may be hiding secrets that have enabled them to maintain profit growth and share prices so that executives gain bonuses and keep their jobs. 

For some time now in international markets there has been a growing distrust in Australia. International analysts believe our housing market is a bubble waiting to collapse and that therefore our bank shares are overpriced. The Volkswagen/Glencore affairs caused that apprehension to again break out. Our miners would have been slashed because of Glencore but the nervousness about Australia spread quickly to the total market led by the banks. The Commonwealth Bank saw its shares fall below the recent share entitlement offer price of $71.50.

The overseas institutions believe that the Australian dollar is going to fall a lot further because the Australian population still does not understand the disaster that is incorporated in the slump in the mining business. We have been insulated by massive Chinese investment in residential real estate. The fall in currency puts that investment in jeopardy. Those who invested in Australian residential developments a few months ago are now losing heavily. If the Australian dollar can fall from US80 cents plus to below US70 cents it can go below US60 cents and even lower. Trust has been broken. 

And of course once it is clear that markets are in a bear phase the shorters will have a party and they thump individual company shares, our currency and anything else that is Australian. In due course prices will recover but in the meantime the so-called shorters (those who sell securities they don't own, betting that the price will fall) are making a killing. Shorters accentuate falls and their covering (buying back stock) can cause sharp rises. The shorters are often big institutions with pipe access to the markets which makes them legal insider traders. So that means that from time to time in this bear market we will have rallies and during those rallies if you are uncomfortable with your equity exposure that is the time to sell.

Right at the moment global capital is looking for a safe haven and the safest haven anyone can find is US bonds which are rising in price albeit they have very low yields. This crack in the share market means that it will make the US Federal Reserve wary about lifting interest rates too far.

In Australia for all of us in the share market the temptation is to quit and sit on the sidelines. But the problem is of course the yields on the sideline are very low and shares in banks and Telstra look even more attractive on the yield basis as the prices fall. It may be the right thing to do to quit the stock market now and try and come back later but for mine I have my equity positions at levels where I am comfortable and took a decision some time ago to ride out any storms but those with very high exposures to equities and particularly those who have borrowed on margin face much tougher decisions. I would still wait for the rally to lower my exposure but it is my view we are now in a bear market. The bull market days are truly gone.

In terms of the mining industry what is unfolding is a massive change in China's demand at a time when too many miners are lifting production. It is going to be a very rough period. But it has taken a Glencore to really underline the problem.