Weekly Market Report

6 December 2022

Global Report

Crypto Finance under scrutiny.

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Local Report

History of, and investment case for, Glencore.

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Global and local indicators.

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Global Report

By Carel La Cock

Crypto currencies and the case for decentralised finance have come under pressure following the recent collapse of FTX, one of the world’s largest crypto exchanges and the cryptocurrency ecosystem, BlockFi. Calls for stringent regulation where currently none exist, followed soon after. Investors were blindsided by the concentration of power in the exchanges which operate in unregulated space, willingly ignorant of the dangers while crypto currencies were making massive gains in the last few years. Ninety percent of all bitcoins have traded on crypto exchanges in 2021, according to economic sociologist, Kory Çalışkan, contradicting the idea of decentralised finance.

It started with the collapse of FTX and its trading arm, Alameda Research, the two companies set up by Sam Bankman-Fried, once the darling of crypto finance. FTX, valued at $32bn at the start of the year started to unravel when CoinDesk revealed that Alameda was holding a large amount of FTT, a trading token created by FTX. Binance then announced that it will be offloading the FTT tokens it held which sparked a collapse in the price of the token. Spooked customers then duly responded by withdrawing $6bn from FTX, revealing an $8bn hole in its balance sheet. Sam Bankman-Fried feverishly searched for funding to plug the hole, but by that time it was too late. The Bahamian regulators froze assets and investors’ funds are now locked up until liquidators can pick through the wreckage.

BlockFi was the next domino to topple. It swiftly halted client withdrawals by filing for voluntary bankruptcy protection soon after. Earlier in the year, FTX had to bail BlockFi out to the tune of $400mn when crypto currencies first showed signs of distress. Alameda borrowed $700mn from BlockFi and days after the collapse of FTX, BlockFi sued Sam Bank-Fried to seize his 7.6% share in internet stockbroker, Robinhood, who gained notoriety during the Game Stop saga last year. In legal filings, BlockFi claims that FTX pledged these shares as collateral in its borrowings. However, it became known that Sam Bankman-Fried listed the shares on its balance sheet presented to potential rescuers.

To make matters worse, FTX claims that it got hacked a few days after the mass client exodus, in what it described as “abnormal transactions.” It is a complete mess and will take clever people an exceedingly long time to clean it up. In the meantime, the debate over regulation in crypto finance rages on. Proponents of regulations have used the downfall of FTX to spearhead their push to formalise the crypto industry. It is strange to think that Europe and the US have no effective oversight of their respective crypto markets, and the carcasses of crypto swindles are strewn across both continents. Europe has at least made some inroads and have drafted the European Union’s Markets in Crypto Assets (MiCA) bill which just needs final approval by the European Parliament, likely to happen by year end. However, a transitional period of 18 months will mean implementation of the bill will only take effect towards the end of 2024.

The US has lagged its European counterparts despite many proposed initiatives. The debate in the US centres around the classification of crypto currencies as either securities or commodities and regulating according to existing rules. US Senator, Cynthia Lummis, tabled a bill in June that would have prevented the disaster at FTX whereby customer’s assets were used by Alameda for trading. The bill is currently with the US Senate finance committee, and she hopes that it will be pushed to the top of the agenda in the new year.

Not everyone is in favour of regulating the crypto industry. Detractors like business school professors Stephen Cecchetti and Kim Schoenholtz argue that it would legitimise an industry that does little to support real economic activity” and “would provide an official seal of approval to a system that currently poses no threat to financial stability.” Furthermore, it “will encourage banks both to purchase crypto assets and to lend against them as collateral, making the banking system vulnerable to plunging market values.” They suggest “Just let crypto burn.”

But until crypto bills are passed, and regulation comes into effect, investors need to do their own due diligence. The fallout from the turmoil in the crypto markets has had an insignificant effect on clients’ portfolios. Earlier this year I wrote that investment trust managers preferred to own shares in crypto exchanges rather than owning the tokens itself. The idea is that it does not matter if prices go up or down, while investors trade digital assets the exchanges make money. It will then come as some relief that all trusts that we hold avoided this red herring. One of our key holdings, RIT Capital Partners, was given multiple opportunities to invest directly into FTX, but declined on each occasion as it did not pass the manager’s high diligence standards. Bill Ackman, CEO, and founder of Pershing Square Capital noted in a Twitter post recently that: “the telephone, the internet, and crypto share one thing in common. Each technology improves on the next in terms of its ability to facilitate fraud.” He does concede that “crypto is here to stay and with proper oversight and regulation, it has the potential to greatly benefit society and grow the global economy.”

Local Report

By Gielie Fourie

INTRODUCTION: The best diversified mining company is probably Glencore. Glencore’s name is an abbreviation of “Global Energy Commodity Resources. Barclays says, “It remains our Top Pick.” Glencore started off as a commodity trading company. Glencore later added mining to its activities. Today Glencore (GLN) is one of the world’s largest globally diversified resource companies. The group engages in the production and marketing of metals and minerals, agricultural products, and energy products, and is the market leader in terms of its commodities trading and marketing business. The company’s supply chain focus (production, refinement, processing, storage, and transport of products) makes it a more defensive business than a pure commodity play.

Glencore is a young company. It was founded in 1974 by Marc Rich (1934 – 2013) as Marc Rich & Co. Rich was a businessperson, and alleged financial criminal with federal charges in the US of tax evasion, wire fraud, racketeering, and making oil deals with Iran. He received a widely criticized presidential pardon from U.S. President Bill Clinton on 20 January 2001, Clinton’s last day in office. The current company was created through a merger of Glencore with Xstrata on 2 May 2013. As of 2015, it ranked tenth in the Fortune Global 500 list of the world’s largest companies. As of July 2022, it is the world’s largest commodity trader.

Ivan Glasenberg, South African, was named CEO in 2002. He retired in 2021, stepping out of the CEO position after 19 years. Fellow South African, Gary Nagle, succeeded him. They both studied at the University of the Witwatersrand, and both are Chartered Accountants. The Senior Independent Director is Gill Marcus, also a South African. Ms Marcus served as the Governor of the South African Reserve Bank from 2009 to 2014. In 2011 mining company Xstrata announced plans to merge with Glencore. Xstrata chief executive was Mick Davis, another South African Chartered Accountant, and a friend of Glasenberg. Davis would head up the new firm, with Glasenberg becoming deputy chief executive. Glasenberg would be reporting to Davis. This arrangement was destined to fail – there was a clash of two strong personalities. On completion of the merger with Xstrata in 2013 Mick Davis resigned. Glasenberg became the CEO of Glencore Xstrata. The name of the company was later changed to Glencore.

FRAUD: On May 24, Glencore Energy UK Limited indicated in court that it would plead guilty to five counts of bribery and two counts of failure to prevent bribery. Glencore stood accused of paying over US$53 million of bribes between 2011 and 2016 to officials in Africa to “secure access to oil and make illicit profit”. The UK Serious Fraud Office (SFO) found that over US$25 million in bribes were paid in Africa. A month ago, it was fined £280 million ($320 million). Glencore faces continued investigations from the Office of the Attorney General of Switzerland and the Dutch Public Prosecution Service. These issues occurred under the watch of the previous CEO, Ivan Glasenberg. CEO, Gary Nagle (46) said in a presentation that globally ethics are at the top of Glencore’s agenda.

THE INVESTMENT CASE FOR GLENCORE: Glencore has a world class portfolio of assets. It is an almost consensus view among miners that copper is one of the most promising commodities. Glencore’s copper business is well positioned to maintain and, if necessary, grow production over the next few decades. Glencore also benefits from the by-product cobalt at mainly its African mines another commodity with a favourable demand outlook. Similarly, zinc and nickel demand are also geared to global growth, with nickel in particular a beneficiary of increasing electric vehicle penetration, given its key role in battery chemistry. On the other side of the spectrum is thermal coal, to which Glencore is also exposed. Under the most ambitious climate commitments, thermal coal-burning would all but disappear by 2050. According to Glencore management, cash flows generated from coal will be directed to more future-facing commodities. Glencore’s commodity basket is more mixed than that of other diversified miners. Industry demand is only expected to begin declining from the mid-2020s. In contrast to its peers BHP and Anglo American, Glencore has no exposure to the iron ore market.

Glencore’s balance sheet and cash flow are strong, allowing them to buy back shares. Net debt is only $2.3 billion, or 4.5% of equity. Market capitalisation is $88 billion (R1.6 trillion). Its credit rating from S&P Ratings is BBB+ with a positive outlook. Glencore had a record financial performance in 1H 2022 – profits were up 40%. That was mainly due to a robust performance from coal. The forward Price to Earnings (PE) ratio is a low 4.12x compared to Anglos 9.07x, BHP 9.51x or South 32 9.10x. Analysts at Barclays has Glencore as their Top Pick, Deutsche Bank has it as a Buy, JP Morgan has it as Overweight.

Analysts’ upside for Glencore varies between 35% and 50% over the next year. Analysts’ consensus is 8 buy ratings with no hold or sell ratings. Elon Musk has shown interest in buying a 10% – 20% stake in Glencore to secure a reliable supply chain for Tesla. Metals like copper, nickel and cobalt are essential to the energy transition to electrification. Glencore’s other commodities are lead, zinc, gold, silver, ferrochrome, coal, and oil. The biggest negative issue is inflation, which is an industry wide problem.

BOTTOM LINE: Glencore’s commodity price basket, apart from coal, has been weaker than that of its peers, and its share price performance has followed suit. Its peers made extraordinary profits from higher iron ore prices caused by large supply disruptions in Brazil, but this is not sustainable. Glencore’s production has also disappointed – a matter being addressed by the company. Glencore is more attractive when longer-term pricing is taken into consideration. Other positive attributes that differentiate Glencore from peers are its profitable commodity trading business and the close alignment of interests between shareholders and its management team. Glencore would add value to any investment portfolio.

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Reference: References can be supplied on request.

The Bottom Line: Innovation and the Magic of Compounding

By Carel La Cock

The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.

Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.

After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.

Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.

As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.

Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.

Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.

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