February 4th, 2008 • Related • Filed Under

Filed Under: Market

Somewhere, Vladimir Putin is chuckling…
First the facts. Just days before BHP Billiton’s (ASX: BHP) London deadline to make a formal offer for Rio Tinto (ASX: RIO), the Aluminium Corporation of China (Chinalco) swept in from the left flank to seize 12? Rio’s U.K. listing. The $15.5 billion raid included an American wingman. Alcoa (NYSE: AA) is a junior partner in the deal, which gives Chinalco a 9?ake in Rio’s dual-listed corporate structure.
What just happened?
The short answer is that China did what South Africa did not: it anticipated future demand and secured ownership of a strategic natural resource. More on South Africa in a moment. But for China, Chinalco’s move gives it a seat at Rio’s table, and thus, a voice in the on-going negotiations between Australia’s two biggest mining stocks about their collective future.

Not a bad weekend if you’re the China Development Bank, one of Chinalco’s financiers. And not a bad weekend if you’re a strategic policy maker in China. The move does not kill the prospect of an OPEC of iron ore-united Pilbara operations under the BHP banner. But it will force BHP to increase its offer for Rio, or recognize that it’s been outflanked by a strategic customer.
Chinalco’s bid valued Rio at four times a BHP share. BHP’s initial offer was a 3-1 swap with Rio shareholders. In the past, these disagreements over the appropriate valuation of mining assets were resolved with cash. Is BHP all in or not? More on strategic business units and Vlad Putin below.
Did you see that power-station coal prices in Newcastle were up 25?st week and 75? 2007? We wrote about the trifecta of causes in the February issue of Diggers and Drillers. Iron ore gets all the buzz for the projected 70?se in the contract price between Aussie producers (and Vale) and Chinese steel makers. But coal is in a nice little bull market of its own.
Part of the action in coal is explained on the supply side. South Africa is in the midst of a power crisis. Demand for electricity has grown faster than installed capacity. Now, the company’s only power company (Eskom) can’t keep up. The government has slapped restrictions on coal exports and imposed rations on electricity for industrial users.
Gold and platinum prices are getting a nice kick as a result, with South African production down for the last two weeks. Is this just a temporary problem, though? Maybe not. South Africa is providing the world with a perfect case study for what happens when energy demand remains high but supply meets the brick wall of physical scarcity.
In the grip of a ferocious winter, China isn’t exporting any coal either. With some of Queensland’s big coal mines flooded, the supply of seaborne coal in the global market has suddenly been choked off. There isn’t much margin for supply error in a world that runs on energy. The scary thing to keep your eye on is how long civil order is maintained when the lights go out in Capetown. Or when the lights go out in Beijing.
Why did we say Vladimir Putin is probably chuckling somewhere this weekend? In 1997 Putin received his Ph.D. from the St. Petersburg Mining Institute for a thesis titled, “The Strategic Planning of Regional Resources Under the Formation of Market Relations.”
It sounds like something out of a 5-year communist party plan, doesn’t it? Well, there is some evidence that Putin’s thesis wasn’t even written by him, and that a good portion was copied from a 1978 book called “Strategic Planning and Policy,” Professors William King and David Cleland of the University of Pittsburgh.
We happen to have a copy of that tome right here on our desk at the Old Hat Factory. It should not be described as a page turner. But thumbing through it this morning, we did come across a term that might put Chinalco’s move on Rio in the kind of light Vladimir Putin sees it: a strategic business unit (SBU).
That is, the trend among the world’s nation states is to view resources as assets too important to be simply signed over to private ownership for the purposes of individual wealth creation. Instead, resources are strategic national assets (when you have them), and strategic liabilities (when you do not have them).
China’s economy is built on industrial production. That production requires raw material inputs, many of them from Australia. “China now represents more than 45 per cent of global seaborne iron ore demand, 22 per cent of copper, 25 per cent of aluminium, and 17 per cent of nickel demand. Its demand for these has more than doubled in the last five years,” according to the Chanticleer column in today’s Australian Financial Review.
In this context, “Rio is no longer a merger candidate; it’s the centrepiece of an auction for some of the world’s most desirable mining properties.” It is, in academic terms, a strategic business unit. The question now is who values it more as a strategic business unit: China or BHP?
That auction is being conducted in public equity markets. But it includes corporations owned by foreign governments, as well as publicly listed corporations and individual punters like yourself. How it all works out will be interesting to want. Ownership of Australia’s resource wealth is what’s at stake.
But more importantly, who’s going to profit the most from Australia’s increasingly co-depending mining relationship with China? Aussie shareholders and investors? Or foreign owners using public markets to secure strategic resources? Hmmn. While you think about that, let us remind you that while the top of the resource heap is providing a lot of drama, there is a lot of business opportunity and earnings growth to be had just beneath the surface. That’s the really good news this week.
And let’s not forget the currency markets, which directly affect commodity prices and thus earnings forecasts for Aussie resource producers. All these resources are priced in U.S. dollars. The dollar finds itself in the unfamiliar position of enjoying a little technical support against its cousin-in-paper-fraud, the euro. Our currency and technical analyst Gabriel Andre reports:
“The last trading sessions of last week confirmed that investors were not ready yet to oversell the US Dollar. Indeed, despite the fall on last Friday’s Asian session at 1.4952 against the Euro, the Greenback gained around 1?ring European and US trading. It is now currently trading around 1.48.

“We were saying a few weeks ago that 1.50 was a strong psychological level for the EUR/USD. It still appears that investors are hesitant to push the US Dollar over this precipice. Of course the interest rate differential between the dollar and everything else has widened with the Fed’s two recent rate cuts. However, these rate cuts were more than expected by the market players, and consequently already priced in the currency markets.
“This is the third time the EUR/USD attempted and failed to reach and break the 1.50 level. So what does the chart show?
“The record low of last November of 1.4968 and last Friday’s low of 1.4952 are now drawing a double-top (points A and B) pattern. With the double-bottom formed by the highs of December and January (points C and D), we have now the medium-term trading channel of the US dollar against the Euro. The currency pair will stay rangy as long as it remains in this channel, any break of one of those two lines (resistance through the points A and B, support through the points C and D) would accelerate strongly the move.
Meanwhile, we expect precious metals to appreciate against all paper currencies for most of this year. But you knew that already. With a growing yield differential and soaring coal and iron ore prices, the Aussie will get even stronger against the greenback this year. You still have time to plan that ski trip to Aspen. Hurry. February is the best month for Colorado’s champagne powder.
Dan Denning
The Daily Reckoning Australia

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