GIR gets a mention at the bottom of the article... Metal Money...

GIR gets a mention at the bottom of the article...


Metal Money
By Tim Treadgold



PORTFOLIO POINT: BHP's takeover play for Rio Tinto means there's definitely more action to come in the resources sector and share prices should rise accordingly.

If you didn’t believe in the resources super-cycle before, you must believe in it now. If there is one result certain from BHP Billiton’s proposed merger with Rio Tinto, it's the re-pricing of the entire mining sector.

Speculation, the force which drove the first five years of what is clearly a multi-decade boom, has nothing to do with BHP Billiton’s attempt to create a $400 billion mining monster.

What’s happening now is all about the fundamental business of acquiring, and supplying, raw materials to countries caught up in the industrial revolution sweeping across Asia.

Put simply, it means that the scramble for raw materials will underpin profits (and share prices) for decades.

It also means that every listed resource company is a takeover target – and it means that the price/earnings multiples normally reserved for less cyclical industrial stocks will be applied to mining stocks because they are now able to demonstrate an earnings stream that stretches beyond the bust which has followed every previous resources boom.

Higher price earnings multiples, plus the prospect of a takeover premium, can only mean one thing – higher share prices.

That’s why high quality miners, such as Oxiana, Zinifex, Alumina, and even lowly Iluka, with its appalling record of falling profits and construction cost blow-outs, will benefit from the acceleration of takeover activity. This flurry of merger activity was triggered two weeks ago by that most aggressive of acquisitors, Xstrata. It was Xstrata’s $23-a-share bid for the high-quality nickel producer, Jubilee Mines, which lit the fuse.

By offering a price that was 33% above the market at the time (against BHP’s first attempt premium offer of 14% for RIO) Xstrata clearly flagged that it remained a fully paid-up member of the resource world’s “stronger for longer� club.

In fact, if you look back at each stage of the resources boom since it started in 2002 it has been Xstrata leading the way.

First, it “stole� MIM from under the noses of Australian investors. Then it tried to steal WMC before losing in a bidding duel with BHP Billiton. Canada’s Falconbridge was the next big prize for Xstrata, and Jubilee a sweet morsel to boost its nickel profile.

In recent weeks there has been talk of Xstrata being the likely bidder for Rio Tinto’s North American coal assets that are for sale in the wake of Rio’s merger with the big Canadian aluminium producer Alcan.

And now there is speculation that Xstrata might even counterbid against BHP for Rio. Newly appointed BHP Billiton boss, Marius Kloppers, understands precisely where Xstrata is coming from, and where it is heading. His early training was at the feet of the man who first proposed a merger of BHP Billiton and Rio Tinto, Brian Gilbertson.

What got Gilbertson fired five years ago might prove to be the making of Kloppers.

Driving forces

The young gun at BHP Billiton is being driven by a number of forces. They are:

Chinese demand for raw materials.
An opportunity to cement pricing power in the hands of miners because in a boom control of supply means control of the market.
A fear that if he doesn’t move quickly BHP Billiton itself becomes a takeover target.

The game being played today in the resources sector is so big, and so important to Australia’s future, that it will soon have a place on the Prime Minister’s table – whoever that might be after November 24.

But shareholders in Rio, BHP and every player in the resources sector must look towards China. Despite its benign appearance as a simple buyer of raw materials, China is being pushed towards becoming an aggressive acquirer of assets itself simply because it has to have the raw material to feed its industrial expansion.

Early skirmishes in the second-tier of the WA iron ore sector -- such as the battle for MidWest -- are a sign that China wants to have direct equity ownership of resource assets if only to guarantee future supply.

Bigger battles are ahead, especially as the major suppliers of material such as iron ore are holding a gun to the head of China’s steel industry by threatening a fresh round of massive price increases.

Talk of a 50-to-100% increase in the price of iron ore has led to a sharp reaction from the highest level of the Chinese government, declaring such an attempt as “unfriendly�.

The Chinese can react in a number of ways: one possibility is a “buyers strike� – which Eureka Report will explore on Monday in an exclusive interview with Michael Kiernan, the former chief executive of Consolidated Minerals and head of a new iron ore exporter, Territory Resources.

Another reaction could be for the Chinese to buy their own iron ore and nickel mines. This is already happening to a limited degree in Africa, and via a limited number of partnerships in Australia.

But, a really big move could see a Chinese bid for the rapidly emerging Fortescue Metals Group, a step which would achieve several aims in a single move. First, it would secure a future source of supply, and secondly it would give the Chinese a position alongside the iron ore mines of BHP Billiton and Rio Tinto in WA’s Pilbara region.

On the Australian market early today, as Rio Tinto was being re-rated sharply higher – it closed up $17.50 to $130.90 (and BHP Billiton saw its price fall 77¢ to $42.47). Fortescue rebounded from a Thursday sell-off, partly inspired by talk of a shareholder revolt over largely irrelevant incidentals such as having too many executive directors and not having one of the big four auditors.

The 13.6% rise in Fortescue’s share price today (November 9) back over the $50 mark almost matched the percentage move by Rio Tinto – a reflection of the expectation that Fortescue, just like Rio, just like the entire Australian resource sector could be “in play�.

Whatever the next moves the simple message for investors is that they are watching a worldwide scramble for raw materials at a time when the mining industry is struggling to meet demand.

Separately, there is the inescapable fact that there are not enough new projects on the drawing boards, or enough ore bodies waiting to be developed (let alone discovered) that can meet the soaring demand flowing from China and India.

As an investor that means you need to maintain, or grow, exposure to resources – and a focus on quality is of equal importance.

Stock picks

So, you say, name the shares. On a commodity-by-commodity basis here’s a theoritical share portfolio structure like this:

Iron ore: after the big two - BHP and RIO - go only for the stocks with haematite (direct shipping) ore. Companies proposing to mine lower-grade magnetite face an enormous barrier in the form of high energy costs. Best of the emerging haematite stocks were listed in Eureka Report on October 17 – BC Iron, Iron Ore Holdings, FerrAus, Territory Resources and Centrex. Two new names for that list are Yilgarn Mining and Giralia which have their feet on excellent deposits and of course, don't forget Fortescue.
Nickel: Xstrata started the ball rolling. Others will follow. Stocks to watch as takeover targets are: Western Areas, Sally Malay, Mincor and Independence (also for its gold position).
Copper: Oxiana, Aditya Birla, Kagara, Jaguar Metals and CopperCo.
Zinc: Zinifex, CBH Resources, Terramin and TNG.