You'd better find a dance partner soon, if you intend to dance in the resource sector. "Xstrata (LON:XTA) has taken centre stage in the latest speculation about mega-mergers in the booming resources sector, after Brazil's CVRD was touted as showing interest in the world's fifth-largest mining company," reports Matt Sullivan today's Age.
Not to be outdone, at least in terms of style, Sinosteel followed up last week's flirtation with MidWest (ASX:MIS) formally proposing a $1.2 billion merger with the little Pilbara ore junior. The Chinese-backed offer has now been made. What next?
How about we pause for a moment and ask what consolidation in the resource industry means?
It could mean that the major producers think the rest of the sector is under priced. This was certainly the case when Tom Albanese made the case to Rio Tinto (ASX:RIO) Shareholders to buy Alcan. But that was six months ago. On an earnings basis, the sector isn't cheap.
But hey, when you're making a mint from record high base metals prices, you have to do something with the cash don't you? You can return in to shareholders (as BHP Billiton (ASX:BHP) did last year). You can invest it in new production (as both BHP and Rio have done in the Pilbara).
Or, if you're confident about the 'glide path' of commodity prices (you think they'll be staying strong for longer) you can simply acquire new production by making cash offers for existing producers. That seems to be the chief motivator of consolidation today-taking advantage of strong demand by buying current production from smaller firms.
The advantage of this is that there's no net increase in production. Ramping up production would be the quickest way to lower prices. However, if you're simply rearranging ownership of existing assets, you don't jeopardise higher prices by upsetting the profitable supply/demand dynamic that currently exists between Australia and China.
So what's the deal? Do the big miners have more cash than they know what to do with? Is this resource land grab the sign of a top in the resource market? Or is it an arm wrestle to see who will own and profit from tangible assets as we move more fully into China's great new century? We'll be sure to ask Greg Canavan from Fat Prophets. He's speaking at our second annual Doomers' Ball tonight down on Collins Street.
We'll have to keep today's reckoning short, as the head reckoner has arrived from India to find out how our little outpost here in Australia is doing. The short answer is: well. The long answer is that independent investors in Australia have the same problem as investors everywhere: where can I find independent analysis of the share market from someone whose interests are aligned with mine?
We think there's always market for a second opinion. Besides, events that used to be considered so improbable that they weren't taken seriously now happen as a matter of course. Ironic, isn't it, that the increased financial connections from securitisation, globalisation, and financialisation have made the world more prone to volatility and sudden shocks...and not safer.
Still, there is a great deal of opportunity as well. More on that tomorrow.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Coffee Addict on 11 December 2007:
The world's population explosion, particularly in South Asia will continue to underwrite resource stocks. The current population of 6.3 Billion will increase to just under 9 billion by 2050. Not withstanding periods of sharp recession and stagflation long term demand for resources will inevitably rise. Large mining companies like Rio Tinto would factor all of this in when considering the value of current and future operations.
By the way, Greg Canavan was correct about the wheat crop failure some months ago. I was wrong. Have fun at the Ball.