As Commodity Prices Slide, Layoffs And Restructurings Follow
In recent days, we've seen these headlines:
The three events may seem unrelated, but in fact, all are part of one big story: the commodities-price collapse.
All over the world, producers of raw materials sold in bulk, such as oil, copper, aluminum and zinc, have been tumbling in value. For most of us, these price changes may have seemed unimportant, or maybe even good. Cheap commodities have helped hold down consumer price inflation this past year.
But now, the reverberations from the commodities plunge are being felt by more and more Americans. This is no longer a story about miner layoffs in remote parts of South Africa or Australia. Now it's about middle-class jobs disappearing from Peoria as sales of mining equipment dry up.
Last week, Caterpillar said it plans to lay off up to 10,000 workers, with a "significant" number of those cuts coming in Illinois. The company says that with equipment orders evaporating, 2016 will "mark the first time in Caterpillar's 90-year history that sales and revenues have decreased four years in a row."
And at Alcoa — short for the Aluminum Company of America — a divorce is coming. The company, founded in 1888 in Pittsburgh, announced it will split into two separate businesses next year.
The old part of Alcoa will chug along with its traditional bauxite-mining, alumina-refining and aluminum-production businesses. The other part will escape the commodity end of the industry to become a "value added" maker of engineered products.
And then there's Glencore. The has a huge trading division that buys and sells commodities, and another arm that mines those materials, such as copper, zinc and coal. And the company, which has about $30 billion in debt, has lost roughly three-quarters of its stock value this year.
Perhaps more than any other company, Glencore provides a disturbing look at what happens when soaring expectations combine with low-interest loans to create high risks.
Five years ago, Glencore could see China buying up commodities at a torrid pace. China needed raw materials for construction of office buildings, roads, manufacturing plants and more. So it wanted to buy lots of zinc.
Zinc is a silvery-white metal used to coat iron and steel to block rust. It's also used to make brass, rubber and semiconductors. In fact, it's the world's fourth-most-consumed metal — after iron, aluminum and copper.
So Glencore mined zinc feverishly and bet heavily on its rising value. And it borrowed a lot for expansions.
At the time, that all made perfect sense. Zinc prices were up, and interest rates were down at rock bottom. Expanding the business seemed like a brilliant idea.
But now that China's growth is dramatically cooling, so is demand for zinc. Prices have fallen about 30 percent just since May. Investors wonder how Glencore is going to repay all of its debt now that revenues are falling.
This Glencore saga explains why the Federal Reserve's decisions on interest rates are so important. The central bank had slashed interest rates during the Great Recession to encourage companies to borrow for expansions. And it worked.
But for commodity companies, it worked too well; many borrowed heavily to splurge on dramatic expansions. Now they are faced with the consequences of this exuberance.
So critics can say that the Fed helped create this mess by keeping rates too low for too long.
But at this point, raising rates could make it even tougher for producers of commodities — whether miners, drillers or farmers — to refinance their debts, making it all the more difficult for them to hang on.
This is why investors and analysts, zinc miners and wheat farmers, hang on every word from the Fed.
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