US, China Trade War Brews As Commodity Prices Climb

Which is more important to Australia: Team America or Beijing's Big Red Machine? It's not quite a transparent questions, because it assumes China will keep on growing at double digit rates in the face of a slower U.S. economy. But for the record, that is precisely the investment position we find ourselves taken.

The U.S. needs China more than China needs the U.S., we recklessly submit. And the brewing trade war will certainly hit both countries in places they'd rather not be hit. But in the end, we like the prospect for China-related growth stories more than U.S. stories. Which makes us, as usual, long-term fans of Aussie resource stocks.

It may not be so obvious now that the world's economic center of gravity has shifted East. But long-term perspectives can change surprisingly quickly. For example, in 1996 BHP sold it's interest in Mongolia's Oyu Tolgoi copper and gold field to Robert Friedland's Ivanhoe Mines for $50 million.

Now $50 million is still a lot of money where I come from, but it's beginning to look like Friedland's purchase price was a) a steal, b) a bargain or c) a blunder by BHP of epic proportions. Oyu Tolgoi is, if the geologists are right, the world's largest un-mined deposit of gold and copper. Ivanhoe and its partner in the project, Rio Tinto, project that the deposit could produce 1 billion bounds of copper and 330,000 ounces of gold a year.

Hmm. Let's see. Breaking out the abacus we find that at a current gold price of US$675 per ounce, one year's of production from the mine (before costs), would fetch around $222 million if sold on the current market.

And copper? Well, in overnight futures trading, copper hit US$3.62 per pound. Here the math is easier. A billion pounds of copper at three dollars and sixty-two cents a pound is three billion, six hundred and twenty million dollars and no cents (if you were writing a check.) That number is also much larger than $50 million, which is what BHP sold its stake in the property for.

Hind sight being what it is, can you fault BHP management for selling out so cheaply? Well, yes. Producers of minerals and metals, conscious of long-term cycles, like to have cash on hand so they can buy at the bottom of cycles, not sell. Perhaps it's unfair to say BHP didn't see the China boom coming. But that's not really the point.

The larger point is that if you can summon the courage to buy something when hardly anyone else wants it, and if you have the patience and the capital to ride out the bottom of the cycle, you'll probably get a good asset at a bargain price. Of course you still have to do your valuation homework. But beefing up your psychological skills is a good start. You have to go against the grain and be willing to look like a fool, something most investors fear even more than losing money.

And finally, the IMF has also warned that the sup-prime meltdown in the U.S. and spotty trouble in emerging markets shows a "lack of credit discipline" by both borrowers and lenders. Duh. What do you expect in a credit boom? When money is a free, discipline is a sell! Better yet, go on margin and short discipline, along with valuation, prudence, and common
sense.

This reminds us of an old saying, although we forget the source. "If we do not discipline ourselves, life will do it for us." You could insert "market" for "life" and the statement would hold up just as well.

Dan Denning
The Daily Reckoning Australia

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