It’s getting nasty in commodity space

Very good piece in the FT on the accounting irregularities at Noble group, Asia’s largest commodity trader, which has come under scrutiny of short sellers,

The critics allege the Hong Kong-based company — which acts as a middleman for buyers and sellers of oil, coal, iron ore and metals — is providing a misleading picture of its financial performance. They claim Singapore-listed Noble has pushed the limits of international accounting standards, so that it can record profits on long-term deals to source and supply commodities well before the company receives any cash payments.

Short sellers argue this is material: the discrepancy between cash flow and accounting profit has accumulated to more than two billion USD over the past few years. Moreover, the value of these long-term contracts (USD 4.6bn) accounts for 90 percent of Nobles book value, way larger than at other commodity traders where this figure is in the low single digits.

But there is more. Noble also has stakes in various mines whose valuation is equally questionable. For instance, Noble’s stake in Australian Yancoal has is valued at USD 12mln on the market, whereas it sits at USD 322mln on Noble’s books, according to its 2014 annual report.

The first question I have: Where is the auditor?

I have seen many discrepancies between carrying values and book values, but this one must be the most egregious one. Especially since no one can argue with a positive outlook, now that the Chinese mandarins cannot even control their stock market anymore, let alone the economy.

The secular commodity bull market has provided many a company (and country) with a one-time windfall. As is typical, they have not attributed this to sheer luck (and record Chinese money growth), but to their own genius. A bull market like that historically comes with dodgy accounting (think of all the bonus possibilities) and it is unlikely that this is limited to the Noble group only, although it looks especially egregious (as far as I can tell from the article, adjusting for the profits and revaluing the participations mentioned, there is not much of equity left).

People usually argue that commodity traders are no banks and hence contagion is limited. I am not sure: think of all the trade financing that has accompanied the rise in global trade over the past 30 years. It sits on the books of the banks as a low margin/low risk assets. Surely a default of a huge commodity trader has the potential to rock this boat…

(Disclosure: short AUD and CNY)

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