What if commodities crashed and none of the producers blinked?
That's pretty much what happened this quarter, with so many major commodities slumping double digits and oil leading the parade, down 25%, yet we saw almost no supply relief. And that supply/demand imbalance is at the heart of what went wrong in quarter number three, and it should have been what went right!
Right now, many, many people want to focus on the Federal Reserve as the be-all and end-all of any and every price movement. There's no doubt that easy Fed policy has played a major role in boosting asset prices in the years since the Great Depression. There's also no doubt that even talking about the Fed tightening has helped lead to a nearly $11 trillion dollar loss in equities globally in this past quarter.
But while the Fed is certainly playing a role in the destruction of stock values, the real culprit is the commodity market, or more specifically, the spillover of the problems of the commodity producers to the equity markets and the lack of common sense exhibited by almost every major producer.
And for that, we have to go back seven years and the lessons that were learned -- incorrectly, it turns out -- from the Great Recession.
There were two takeaways. The first was that our downturn was much sharper than we thought it would be and has led to a host of ramifications, including lower interest rates that still produced slower growth than expected as well as a much more rigorous, rule-bound financial system. In short, we weren't going to let what happened here with our banks happen again, and the Fed wasn't going to allow us to slip back into recession.
But away from us there was a different takeaway, namely that the United States would be mired in slow growth forever but that China's star would rise and take up the slack. In many ways, we were viewed as a late-stage capitalist nation incapable of regaining footing, while China came out of the financial debacle with wings on, an emerging market that could grow high single-digits no matter what for as far as the eye can see.
So many companies at that moment decided to de-emphasize the U.S. and focus on China. As Caterpillar (CAT) CEO Doug Oberhelman said when he came to Wall Street in August of 2010, "we are stepping up big-time and putting our money where our mouths are. We're going to play offense and we're going to win. We will win China."
In that sense, Cat's a microcosm for the moment because it proceeded to purchase ERA, a maker of Chinese mining roof supports for $677 million and it paid $8.6 billion all in for Bucyrus, a maker of mining equipment principally used in coal production, for $8.6 billion. Both were disastrous, with ERA being written off soon after and Bucyrus' business dropping like a stone. Bucyrus was a lot like Joy Global (JOY), which is down 67% for the year and is worth $1.4 billion now.
I am not picking on CAT. In fact, it is faring better than most. What matters, though, is that almost every single one of Cat's clients is in the minerals, mining and oil and gas businesses and those are at the epicenter of the weakness in the world. Because China demand for minerals, including, coal, copper and iron ore, was perceived as endless, you had mergers like Alpha Natural (ANR) buying Massey for $7.1 billion back in 2011 to play the China- driven coal super cycle. You had Freeport-McMoRan (FCX) dramatically expanding mining capacity, Rio Tinto (RIO) flooding the world with aluminum and Vale (VALE), BHP Billiton (BHP) and Rio ramping production in iron, as well as every company, state, private, independent, drilling for more oil.
It was all centered on China, with the last deal, Glencore's (GLCNF) $41 billion purchase of gigantic copper company Xstrata for $41 billion, the worst of them all.
Now China's demand for commodities of all sorts is pretty much falling off a cliff. But none of these companies has really throttled back production. The resource companies, from Petrobras (PBR) and Vale in Brazil, to Chesapeake (CHK) in the U.S., which just laid off 15% of its workforce, to Glencore are all now ridiculously strapped. But no one has really blinked and gluts exist everywhere.
That, not the Fed, is behind much of this last rout, and it hasn't ended because there's been little rationality and a lot of hope that China will come back. It's no coincidence that my two biggest worries at this moment are Petrobras and Glencore. They were the worst offenders.
So, as the quarter winds down, remember, it's not just the Fed, it's China, and decisions made years ago to meet demand that's now going away. That's the real issue, not a Fed tightening, which, of course, will only make things tougher as the year goes on.