The Ukrainian war has claimed thousands of lives. Commodity trading is not one of its victims. The horrific conflict may provide it with a lease of life. The field has been in the doldrums since the 2014 commodity slump.
Commodity traders play the same role that DHL and FedEx Corp do in the delivery of parcels. They connect buyers and sellers for products ranging from oil to orange juice. Its practitioners include Glencore, Wilmar International and Olam International.
Commodity traders thrive during war and sanctions. The business takes its inspiration from Marc Rich, the master of this trade.
Rich died in 2013 but he would relish the severe sanctions that Russia is facing. Rich ran a massive commodity trading empire during a scandalous career. He was a college dropout who began working in the early 1970s for a metals dealer called Philipp Brothers.
In 1974, he started Marc Rich & Co from a small apartment. He soon found a magic formula. He would find a way to supply countries facing trade bans. Rich was immensely confident, despite his humble background. He was a well-dressed charmer who cultivated government officials with Cuban cigars.
Rich’s fortunes rose with the 1973 Arab-Israeli war. The Arab oil producers imposed an oil embargo. Oil was sold to desperate American companies at a vast premium.
He later profited from trading with rogue regimes such as Franco’s Spain and Israel. The Soviet Union was a major client.
His crowning success was supplying oil to apartheid South Africa. In the 1970s and 80s, South Africa was a pariah state. Most oil-producing countries such as Saudi Arabia and Iran forbade the sale of even a drop of oil to South Africa.
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Rich sensed an opportunity. He created a shadow company called Minoil. He was able to up to US$10 billion worth of oil to South Africa through this entity. Marc Rich made a profit of US$8 per barrel on this trade. This amounted to US$2 billion in 1979, which is about US$8 billion ($10.9 billion) in today’s money.
In 1983, the US charged Rich with racketeering. He evaded arrest by retreating to Switzerland.
Rich’s road to riches may inspire commodity traders today. Severe sanctions have been imposed on Russia. It will cripple Russia’s status as a commodity player. Russian banks have lost their access to the Swift system, which is a vital cog in the commodity markets. A bank without Swift cannot conduct international transactions.
Commodity traders prosper by exploiting inefficiencies. Rich may have broken the law by defying sanctions. However, there are legal means to supply commodities to isolated regimes.
Commodity traders collect margins from the difference between the seller and buyer of a commodity. The spread is a function of commodity prices. The commodity traders’ profits have been strongly correlated with commodity prices. The Goldman Sachs Commodity Index (GSCI) is an excellent proxy for commodity prices. It includes energy, agriculture and gold.
The last eight years have been cruel to commodity traders. The GSCI has fallen 63%. The ebitda margins of Glencore, Wilmar and Olam have roughly halved in this period.
The impact on the commodity trader’s stock price has been severe. Glencore is a Swiss-headquartered trader with a focus on mining, oil and gas. It traces its origins to Marc Rich & Co. Glencore lost three-fourths of market capitalisation during the 2014–2016 rout.
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It has since recovered as commodity prices have risen. However, at a price to book ratio of 0.5, it is a third of its 2014 level.
Wilmar and Olam are both headquartered in Singapore, which provides tax incentives for traders. Wilmar is one of the world’s largest agricultural traders. It supplies palm oil, soybeans, and sugar. Food shortages could widen Wilmar’s gross margins.
Similarly, Olam, a food supplier, could thrive. It operates in over 50 African and Asian countries. It sources spices, lentils, chocolates and cashews for multinationals. Like Glencore, it has suffered in the commodity bear run. Its price to book ratio is a third lower than in 2014.
Commodity prices are poised to rise. Supply has been disrupted by the war. Demand is burgeoning due to the Covid recovery. Commodity traders may be an ideal way to ride this trend. Marc Rich died a pariah. But the business that he mastered may thrive.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer and author of Investing in the Covid Era. He does not hold any position in the
stocks mentioned in these columns.
Photos: Bloomberg; Amazon.com
