Miners Don’t Gotta Mine

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Here is a question to begin this Friday’s Daily Reckoning: can there be financial stability in Europe if the assets of Europe’s banks are the liabilities of Europe’s governments and some of Europe’s governments are going broke?

We’ll get back to that question a bit later. But warming to today’s task, we’ll look at the mega-rally in U.S. stocks overnight and the big fight back/smack down by the leader of the nation’s bureaucratic class.

But first, there’s nothing like the smell of a short-squeeze in the morning, is there? Slipstream Trader Murray Dawes was calling for it all week. And he was busy getting into trades to profit from it should it arrive. Overnight it seems to have arrived with monster truck force.

The big blue chip Dow stocks were up 284 points, or 2.85%. But in the tech and small cap sectors, the gains were even bigger. For example, the Russel 2000 index of U.S. small cap stocks was up 4.34%.

That’s a good day’s work. It reminded us of the old adage that small caps tend to lead the market up when things are bullish and fall hardest when they are bearish. With that in mind, take a look at the chart below.

The ASX/200 vs. U.S. Small Caps and Blue Chips

The ASX/200 vs. U.S. Small Caps and Blue Chips

Australian Small-Cap Investigator editor Kris Sayce and your editor were talking about the advisability of making new recommendations in a market like this earlier in the week. Ultimately, along with Diggers and Drillers editor Alex Cowie, we decided that they ought to publish their best investment ideas regardless of the market. This means you focus on good companies – but you’re fully conscious the market you’re investing is dangerous.

Both Kris and Alex published their new recommendations last night. And according to the chart above, the timing could be good. Since mid-April Aussie stocks have fallen further and risen less fast than U.S. counterparts. The chart above includes Thursday’s U.S. trading session. But depending on how today’s session goes in Australia, that little green line at the bottom could be a lot higher.

Both Kris and Alex spent a lot of time in their respective reports talking about risk because there’ so much of it going around. You’ve got political risk in Europe. Geopolitical risk in North Korea. Sovereign risk here in Australia. And that’s all on top of the normal risk you take as a common stock investor in public companies engaged in enterprises with inherently unpredictable outcomes.

To be perfectly candid, with so many external forces whipsawing market prices, it is very difficult to be an investor in this market. It is more of a traders and speculators market. In our own newsletter, Australian Wealth Gameplan, we have a few core positions leveraged to a rising gold price and a falling Aussie dollar. Our value investing sleuth Greg Canavan pointed out earlier this week than in a market like this, the best strategy is to buy companies selling at a discount to book value to give yourself a margin of safety.

So, from the speculator to the bargain hunter to the generally risk averse (conscious of the possibility of the systemic collapse of leveraged global financial system), the market requires you to make a decision. Doing nothing is a decision, too. Yes, yes, it sounds post-modern, that inaction is a form of action. But in financial terms, being in cash because you prefer liquidity is a position too.

Our view is that the sense of relief over Europe’s sovereign risks is fundamentally stupid. Or ignorant. Or obtuse. Or wilful self-deception. The banks of Europe are stuffed with government debt. And when one man’s asset is another man’s liability, both parties are the poorer if the debtor cannot realistically repay.

His credits must be written down. His debts must be restructured. And the public balance sheet must be shrunk the same way private and non-financial corporate balance sheets have shrunk. Liquidate the bad investments and move on to a frontier of economic possibilities. That’s the future. For the present, we seem mired in the past.

“Whatever yardstick you care to choose,” writes Edmund Conway in the U.K.’s Telegraph, “share-price moves, the rates at which banks lend to each other, measures of volatility – we are now in a similar position to 2008. Europe’s problem is that the unfortunate game of pass-the-parcel came at just the wrong moment. It resulted in a hefty extra amount of debt being lumped on to its member states’ balance sheets when they were least-equipped to deal with it.”

So what if Europe’s problems haven’t really gone away? Does that mean rallies like this should be sold before the next leg of the Global Financial Crisis, where national governments really do default on their debt? And in the meantime, Europe’s panic attack has obscured very real structural problems in the U.S. and Chinese economies, both related to housing prices and the role they play with bank collateral.

Hmm. If it turns out the global balance sheet in the age of globalisation and securitisation was over-leveraged and debt-laden, then the next round of the GFC is going to make the first one look like a tea-party.

Not THAT kind of tea-party, although it’s fair to see that when a nation’s state finances collapse, the probability for social instability goes up a lot. Inflation and warfare are old bedfellows and campaigners. They know how to have a bad time.

Yet all of this might seem terribly far-fetched or unlikely to policy makers in Canberra and miners in Perth. The two continue to publicly quarrel in front of international capital markets to the detriment of Australia’s reputation as a safe destination for foreign investments. In order to save Australia, it was first necessary to castrate the mining industry.

Speaking to the Senate yesterday, Treasury Secretary Ken Henry knocked backed claims that the mining industry saved Australia from the worst of the GFC (which he apparently thinks is over). He said, “Suggestions that the Australian mining industry saved the Australian economy from recession are curious to say the least…. These statements are not supported by facts.”

We couldn’t find a quotation in which the Treasurer gave credit to Canberra for accounting for up to 60% of Australia’s exports in the last two years, by dollar value. But if he was referring to, say, the volume of words belched out by the government giving itself credit for being so smart, he’s probably right.

Really the most worrying words the Treasurer uttered, in our mind, were these: “Frankly, there is more than enough investment in train in the mining sector. The limit is access to labour and the capital needed to undertake the projects.” He was apparently responding to the claim that the new resource tax will lead to less investment, not more, as both he and the government claim.

The one factor in all this that Dr. Henry and the government seem to be leaving out is free will. Project decisions in the mining industry are not compulsory. The miners can’t walk away from projects that are already producing. This accounts for some of the fury over a tax that is retrospective.

But it’s as if the government believes many many mining projects will go ahead regardless of the policy…just because. As if the companies will stop making investment decisions based on the rate of return and the cost of the capital. They’ll just keep digging and drilling because that’s what they do, and if they don’t the government won’t have any profits to tax.

Beavers must dam. Fish gotta swim. Birds gotta fly. But miners don’t gotta mine in Australia.

In the real world of the private sector, decisions about what to produce are not determined by abstract public policy goals, which are themselves based on personal prejudices about the “appropriate” level of profit.

In the real word, final investment decisions are determined by what consumers want and whether a firm can deliver what the market wants at a profit. There is no requirement that Australia export iron ore or coal because it has them. If the miners can’t do it a profit that satisfies shareholders, they won’t do it at all, at least not here.

Perhaps that’s what the government wants in the end, to drive the mining companies from Australia, but not before confiscating as much revenue as possible. Perhaps the government wants the mining companies to hand back all their leases and turn the business of producing mineral wealth over to the people who really know how to do it: public servants and elected officials.

We’ll see how that works out. But it’s looking more and more like an international capital strike against Australia is a real possibility. For one, there’s a brewing credit crunch coming from an inevitable sovereign debt default in Europe.

Secondly, Australia’s public officials are looking anything but reasonable and sensible in the court of international capital market opinion. They are looking like grasping, blundering, bullying, but well-meaning dunderheads who have demonstrated a first-class ignorance of how wealth is created. The Rudd government has wanted to lead the world on a lot of issues. It’s well on its way.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. The Henry mantra is derived from the logic of the Keating era, the trade account doesn’t matter, the CAD doesn’t matter, the access to foreign capital account is all that matters. With debt and funny money/foreign investment you can fractionally create capital gains that turn your two flies going up the wall into something that makes you feel wealthy enough to borrow past no tommorrow to invest in bubble class assets and hire all the dog walkers, Brazilian waxers, personal trainers that we can possibly import on student visas. And while this happens the GST revenues for Henry grew and grew until someone said we had to pay real risk rates on that imported capital/debt and our balance sheets went poof (the end of APRA’s don’t ask don’t tell and their easy prudential tick of using stress tests that give worst cases like a common cold is to swine flu symptoms)

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  2. Umm, it’s axiomatic that miners won’t mine if there’s not a buck in it.

    Whatever else you may think of Ken Henry there is no doubt he knows this.

    Indeed it seems to me the RSPT is designed with this precisely in mind; royalties (which are an input cost and not a tax on profit) are very inefficient and most miners including the big boys want them gone.

    It’s interesting to note that most miners are not nearly as opposed to this as the big players BHP and Rio (and Andrew Forrest is simply using this as a smoke screen as cover for his costly financing mistakes).

    Speaking of the big boys; no one likes to part with a windfall gain but a windfall is what these two in particular enjoy. Their original investment decisions were not made predicated on there being a mining boom and their future decisions should not be either.

    No, the real issue these miners face, and the reason the “we’ll mine elsewhere” argument won’t fly, is that if the RSPT gets off the ground here it will be adopted elsewhere very quickly. Just you wait and see.

    This is why big miners are using everything they have to stop it.

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  3. To make the claim that nations e.g. China will cease purchasing our natural resources due to very slight price increases is like stating that Australian motorists will case to drive over the Easter/Christmas period because the major fuel retailers decide to gauge them over this period. It’s fear mongering at its purest.

    Once something is considered to be a ‘commodity’ and of value, there will always be a willing audience to purchase. What they miners are up in arms about is their potential to keep raping this land for maximum profit and with little or no consequence. It is the height of greed in its purest form. I think this was highlighted when a select group of a dozen or so miner CEO’s and GM’s stood up at a press conference, in their $5,000 tailored suits and stated their utter displeasure in a unison chorus.

    As a nation we are so naive, we allow people who seek to give us nothing, the pleasure in stealing from us what we cannot ever replace nor reproduce. We allow them to sell it to a foreign nation who will eventually turn it into a consumable item we will no doubt pay a significant premium to reacquire in its new from. Heck i know in my life time i will see this ‘great’ country of ours buying back some of these stock piles China has acquired, at a premium, to meet our own demands.

    This tax is essentially, it should have been established from the very beginning of this movement in our resource sell off, and will have NO impact on the volume sold and its costs and will deliver dividends for generations to come.

    We shake out heads at wall street raping and pillaging housing for ‘profits at any cost’ but throw our arms up in disgust when miners may need to cut back on their insane profit margins, for the sake of our nationally development and growth?!

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  4. I love the key comment, “They are looking like grasping, blundering, bullying, but well-meaning dunderheads who have demonstrated a first-class ignorance of how wealth is created.” You have a way with words. And, in fact, if we could all learn to ridicule our elected representstives in this way, we might get a better class of elected representative; one who might understand a bit more of how wealth is created.

    Jeff Steele
    North Carolina
    USA

    Jeff Steele
    May 30, 2010
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  5. Excellent article Dan, and pretty funny! Who said sarcasm was the lowest form of humour? :)

    Lord Christopher Monckton may be right in his view that the Marxists have finally regrouped after the collapse of the USSR. All the indications are there in the US. No, actually they’re not just indications. It seems the plan is in full motion right before our eyes. Reckon our bold, trend setting pollies are influenced by The US and Europe? Nehhh

    Interesting comments guys. I expect though that on Satudays, the mining execs are in the office creating the wealth that we all feed on. Meanwhile, Bruce and Realist are surfing around, character assasinating the the successful of our society, simply because they are.

    Anyone lived in NZ? It’s looking attractive.

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  6. wasabu writes: “the mining execs are in the office creating the wealth that we all feed on”.

    Great. If it were true.

    But it isn’t.

    Mining accounts for about 7% of GDP. It employs less than 2% of the population. It provides a share of national savings by way of direct investment and super for those with enough savings to invest. Last time I looked the level of private indebtedness suggests this benefits very few Australians.

    Bottom line: it’s hardly “the wealth that we all feed on”.

    No point is responding to the rest of your right wing reactionary rant.

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  7. Sweet Bruce, maybe you can suggest another equally large source of foreign income that we can tap into then? Hot air from Canberra maybe?

    Total Australian industry exports (current prices) totalled $249.5 billion in 2009, tobe 9.3 per cent lower than in 2008.

    •Agricultural exports accounted for 4.6 per cent of total exports in 2009, up from 3.9 per cent in 2008.
    •Mining exports accounted for 37.6 per cent of total exports in 2009, down from 39.3 per cent in 2008.
    •Manufacturing exports accounted for 32.5 per cent of total exports in 2009, down from 34.1 per cent in 2008.
    •Services exports accounted for 21.3 per cent of total exports in 2009, up from 19.2 per cent in 2008.
    •Exports not specifically classified to the above industries account for the remaining 4 per cent.

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  8. Bruce and Don, we have fed on the wealth generated by leveraging our grandkids to foreigners. You are both right, once the debt gets priced according to risk there is nothing to replace the tax ticket clipping of economic activity directly generated by the foreign debt – asset price inflation – consumerism troika. And Don, you merely parrot Henry – ie: we may as well do one last throw of the dice to create a bottom in the tax base …. when he should already be cutting the public service hard like the Europeans and owning up to his past crimes with the bankster estate to all the electorate that is about to find out that its asset base is b/s..

    But mining taxation and royalties cuts across so many sectors and various states of integration with production that the grab all tax rake is just another simplistic socialist folly that must end in disaster for the various componentys that have to be globally competitive for capital and resource market price.

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  9. My understanding is miners were not averse to restructuring the tax and paying more. That fool Rudd blew the surplus and created a huge deficit, he wants to continue the illusion of being Mr Popular so won’t take the hard decision to now reign in his debt. Hence they thought the miners looked a good target for a tax gravy train. Now we are hearing all this fair share BS, that is just a socialist appeal to those already on the public teat to support them.

    Unfortunately in Australia we have evolved a culture where once a fair go meant a fair chance into one where the parasites want something for nothing. We all agree on safety nets, but now have an expensive system of huge welfare and a huge bureaucracy to administer it.

    Do we want a fair go for the bludgers or a fair go for the country so that our kids have a safe, economically strong place to inherent? Do the math, when is a shrinking private sector bludgeoned by a socialist state no longer able to pay for the wages and programs of its well paid masters?

    Chunkton
    May 31, 2010
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  10. Ross: “we have fed on the wealth generated by leveraging our grandkids to foreigners”.

    Yes, I could not agree more! That one really is the elephant in the room.

    Don: “maybe you can suggest another equally large source of foreign income that we can tap into then? Hot air from Canberra maybe?”

    It’s a question of eggs and baskets Don. Do you really want even more of our future prosperity depending exclusively on mining? Take this to an extreme and you have a nation like Saudi Arabia which is very wealthy for one reason but that wealth is owned by a tiny fraction of the population.

    It’s not the sort of future I’d like to see for Australia.

    There’s no doubt an RSPT would be redistributive (to the extent that mining would shoulder a larger share of the tax burden than other sectors) but given that it’s a natural resource and of finite availability I would argue that this is as it should be if we’re to start addressing the massive debt we’ve bequeathed to our children (and not just foreign debt either) and ensure our kids all have a decent chance at earning a reasonable income from their productive employment. Like I said, mining employs less than 2% directly and supports less than 10% of national employment indirectly.

    Personally, I would like to see proceeds of an RSPT used in part the way Norway has done with its oil; i.e. invested so as to maximize its future foreign income generating potential. That way the spoils of this finite resource can be used to defray the massive foreign debt accumulated over the past 50 years.

    As to your question about alternatives Don, I would suggest that if an RSPT slowed the pace of mining growth to a more sustainable level (but supported mining in leaner times, as it’s designed to do) and the real productive capacity in the economy otherwise freed up was deployed to energize manufacturing and service sectors (exports and import competing) we would (along with an inherently lower dollar) have a more broadly based and internationally competitive economy capable of making up more than the difference left by the slower rate of resource extraction.

    And Ross, to the question of remaining globally competitive, it is of course a given that we must remain so as a nation but as I have argued above, if the RSPT takes off here it will be adopted elsewhere and our competitive advantage will not be eroded. And even if it did lower our competitiveness in the short term, I would argue that energizing other sectors of the economy with forward thinking investment in part derived from exploiting a “once in the planet’s history” source of wealth, I think this sets up a much better future for my kids and yours, and theirs and…

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  11. “That fool Rudd blew the surplus and created a huge deficit”
    Well you have your opinion Chunkton and i have mine. The total budget deficits were not just caused by spending but by a massive fall off in revenue from the private sector(including from the mining industry).The majority of the spending(immediate cash handouts..instead of tax relief at end of year, insulation program, schools infrastructure etc) whether perfect or not were designed for a purpose and there are many thankful in the private sector for their jobs and small businesses that the previous surplus was spent. The expenditure was/is largely non recurrent and the stimulus will not of itself be the cause of any long term debt issues,so move on.A lot of the expenditure also came back (and is still coming back)in the form of tax revenue from the economic activity it generated and the floor it put under the social fabric at the time.A government has social responsibilities, an overseas based company has none that interfere with profit to shareholders. I have concerns with some housing grants and potential market distortions flowing from that, even though not a recurrent expenditure item either. it is where to from here that is important and bringing the present recurrent expenditure items under control as well as any new programs of a recurrent and one off nature.Anyone preparing budgets knows it is the fixed costs/ recurrent expenditure items that cause the most concern.The tax revenue from the mining has indeed been of assistance but they are Australian assets and a fairer return going forward is reasonable.

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  12. I have been in the mining industry nearly 20 years, I have seen the effects of the aussie dollar high and low, metal prices through the floor and through the roof. This rent tax will be like other changes, some mines will keep going, others will go under or not start at all. I chuckle when people squeal when copper drops below $3 US per pound. How did we survive when it was 70 cents? (ok the Aussie dollar was lower but that is the nature of the economy)

    I am acutely aware of the situation Australia is in with mining income and the effect it has on the economy, good effects and bad. During the 90’s and early 21st century all those different events washed over Australia, some industries prospered whilst others dropped away as any reasonably balanced economy should. My concern during that time and now was Australia becoming like a mining town where everything is roses when the mines are going good and then busts when it all goes pear shaped. So I do agree with you guys that the mining boom should be used as an opportunity to restructure and build other industries or assets.

    What is really depressing about this tax for me is not the tax itself, it is what it is going to be spent on. No nation building, no long term plan, no bloody nothing. Just more handouts, grandstanding, greasing up for stuff all benefit whilst the politicans squawk about like chooks about issues that long term mean bugger all.

    I look at a city like Cairns which has bet the farm on tourism as its major industry. At the moment it is feeling the effects of that decision. Unemployment around 14%, businesses struggling, bad socian problems, local government reduced to begging for handouts and whinging about not getting more money to help with their problems. No talk about the future and what to do now or restructuring things to get new industries going to hedge their bets. They bandy about ridiculous ideas such as incentives for people to holiday here or a new Water World Theme park or some other waste of time. People just can’t get over it and the mental intertia just goes on and on and on and this is my main worry for Australia and mining. Great while it is booming but let’s plan to balancing things out for the inevitable bust.

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  13. Don, alarm bells rang for me when I heard on the radio that the government had invoked some sort of ‘national emergency’ powers to use ‘taxpayer’ funds to advertise this ‘super profits’ tax.

    Smells fishy to me, I think there might be something to this than the government is letting on. Observing the exploding government bond issuance makes me think I know what it is.

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  14. You know the old saying Justin – Never let a crisis go to waste. I don’t know if it is a saying actually but I am sure someone has coined it in some form :)

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  15. If this tax* does happen, will wages come down in the mining sector. I would imagine that it would be hard to do in the remote areas with a 25% wage drop. $2000 a week rent will still stay the same…

    But in the big cities will the lucrative contracts and projects in the mining and heavy engineering sector come down by 25% in labour cost. I wonder.

    I suppose the flow on effect could be a benefit to government sponsored infrastructure projects who could then command top dollar for money hungry talent. We could see talented mining executives designing school halls and participating in a revitalized infrastructure mini boom culminating in an 8 lane freeway to Dubbo and beyond.

    Its time to buy shares in flag and bunting companies.
    Come in spinner :)

    tax* Yes, yes – all tax sucks and is a blantant hand over fist money grab – just to keep the ed on side.

    zytron bloodworthy
    June 1, 2010
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  16. Too subtle Biker – He’ll never pick up on it. :)

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  17. “we have fed on the wealth generated by leveraging our grandkids to foreigners” … Last time I looked “Aussies” either had slanty eyes or wore berquas – Them that weren’t convict descendents or Abos – Apologies to youse coupla Eyetalians and Ouzo drinkers out there! So who exactly are these foreigners we’ve sold our grandkids too? – Some modern day Yank and Brits bankers would SEEM to be the truth of it?

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  18. “Too subtle Biker – He’ll never pick up on it. :) ”

    You’re not wrong, Ned.

    Some curious stuff from Bill on the DR(US) site today. Read his comment:

    “But what’s all this bellyaching about? Saving money is a good thing. It makes you richer. And it gives the economy the capital it needs to build new things. In China, for example, they’ve got a train that goes more than 400 kilometers an hour. At least, that’s what they tell us. China can build things like that because it has savings. (Among other things…) America can’t do it. It doesn’t have the money.”

    Strange comment about a nation which spends up to $US18 billion on space exploration annually. Really more about priorities, isn’t it?!~ ;)

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  19. Another day another project down the tubes – thanks to the new tax! Say goodbye to Ernest Henry everyone. I can assure you that it was not the collapse in the gold price that canned that one. Not to worry though, that means all that ore will be waiting for future generations although they will have to build another processing plant to treat it by then – oh bugger :(

    I feel for Cloncurry, that is a massive hit in the chops. No schadenfruede either as the GM of Ernest married my ex – a sad day for everyone.

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