Bear market analysis of industrial metals : from a credit perspective
1University of Oulu, Oulu Business School, Department of Finance, Finance
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The purpose of this thesis is to study the relationship between industrial metals bear cycles and credit dynamics of the mining companies. This thesis is the first piece of empirical research focusing on the topic. The objective of the paper is two-fold. First, I examine the characteristics of historical metal cycles and identify the turning points in the underlying metal index series. Second, I study how the leverage ratios and cost of debt of the mining companies develop during the metal market contraction phases. My aim is to find out if the re-pricing of debt and compression of CDS spread and yield on mining companies happen before the metal prices turn, i.e. if the CDS market and the bond market act as leading indicators for metal markets. The data used in this study is gathered from two sources. First, a database of monthly metal price series is collected from the UNCTAD database for the period January 1972-May 2017. Second, in order to calculate leverage ratios for the mining companies, I download net debt, equity and EBITDA data at a yearly frequency from Bloomberg, spanning from 1992 to 2016. The start date is determined by the availability of the data series. Also, CDS spread and yield-to-maturity data is downloaded from Bloomberg. Due to relatively poor availability of data, the sample period runs from September 2002 to May 2017. My results indicate that leverage ratios of mining companies are prone to increase during periods of a metal bear market. This is likely due to fact that the continued deterioration in commodity prices during bear markets will undermine company’s cash flow. As the expansion projects take usually several years to complete, it is likely that the operating cash flow deteriorates faster than the cutbacks and capex reductions carried out by the mining companies. Second, my results also suggest that the cost of debt increases significantly for the miners during bear market phases. During the periods of continuously declining metal prices investors are likely to re-price the companies’ debt exposure. Finally, while there can be observed clear spikes both in CDS spreads and yield-to-maturities when metal bear market is approaching to its end, I do not find any evidence that the CDS spreads or the yield-to-maturities of the mining companies would reverse their trend before the metal market does. In other words, in most cases the turn in the CDS market and the bond market happen simultaneously with the metal markets.
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