26/10/2011 - 10:25

Has Goldman put kibosh on iron ore?

26/10/2011 - 10:25

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Iron ore miners may have to deal with falling prices in the coming months and years.

‘ALL boats lift on a rising tide’ is one of those old stock market sayings investors in mining companies tend to forget and managers pretend is not true.

What it means is that when commodity prices are going up, so are profits (and share prices), without managers actually being required to manage – they just bank the cheques and tell the world how clever they are.

The test of management comes when the tide goes out, which is what could be happening over the next year or so as commodity customers, the steel mills and manufacturing industries of China, the US and Europe, cut back on orders.

Just how far they cut back is the great unknown from the return of the GFC (European chapter).

It is at times like these, when prices slide, that the nifty analogy about boats rising on the tide can be swapped for a more critical assessment of management ability in a boom – ‘in a stiff breeze even turkeys can fly’.

Whether it’s the tide going out or the lack of breeze that has grounded the turkeys, it will be interesting to see how the Australian government – the third, and unwelcome, player in the mine-management game – handles a period of lower commodity prices.

Until recently, governments’ major interest in the commodity-price cycle was either collecting royalties at a state level, and income tax at a federal level.

That changed when the federal government signed up as full member of the ‘this time it’s different’ club of true believers in a resources boom lasting forever and famously designed the mining super profits tax (now the Minerals Resource Rent Tax).

For anyone in Sydney, Melbourne or Canberra, the super-profits tax seemed a perfectly logical way of stripping out extra revenue from mining companies, and to then factor into future income streams of government a perpetually rising share of profits.

Older heads in the resource states of Western Australia and Queensland were amused by the fact that the biggest bulls in the commodity paddock were the grey-cardigan brigade of Treasury, who have minimal experience of the inevitable boom/bust nature of the resources cycle.

In other words, an awful lot of the revenue that Treasury reckons will be raised from the coal and iron ore industries by the mining tax might now be in jeopardy if some recent price forecast come true.

Take iron ore, for example. A few weeks ago the clever chaps at Goldman Sachs, arguably the world’s top investment bank, were predicting an average iron ore price of $US175 a tonne. In mid-October as Europe tottered towards the edge of an economic cliff, the 2011 average price was lowered to $US171/t, a modest $US4/t cut in price projections.

It’s what might come next that ought to alarm Treasury and everyone else riding the iron ore sector.

According to Goldman, the 2012 average iron ore price will be $US140/t – a price forecast that represents a $US30/t haircut on the $US170/t of weeks ago.

It gets worse. The 2013 average iron ore price is now tipped to be $US120/t (the old tip was $US160/t), with a further slide to $US125/t in 2014 ($US125/t previously) – and from 2015 onward the average price is predicted to be a very lowly $US75/t.

Whether Goldman’s guesses are accurate will only be revealed over time. However, given that the firm nicknamed the ‘Vampire Squid’ is right more often that it is wrong, there are a few people in the WA iron ore business who might soon be forced to manage rather than promenade around telling the world how clever they are.

As for the magnetite mining crowd basing their industry on processing low-grade ore, a price of $US75/t might prove to be the kiss of death.

Not-so friendly skies

SPEAKING of industries looking down the barrel it is hard to avoid the conclusion that Qantas as we have known it is a dead duck – or road kill, given its kangaroo logo – with, or without a quick end to its current union troubles.

The problem for Qantas is that its entire business model is so very ‘yesterday’, based on a thesis that air travel is glamorous and customers will pay high prices for little extras such as ‘free’ in-flight booze and the personal care of attentive stewards.

That approach to air travel died a decade ago. Today, it’s all about driving costs lower with most customers happy to pay less and forgo an in-flight chicken sandwich or similar. The problem is that for Qantas to really compete, even with its own creation, Jetstar, it will be forced to sack an awful lot of its 35,000 employees and contractors, and even then might not emerge with a viable business.

A more interesting, and creative alternative is for Qantas management to allow the current multiple-union disputes to worsen to the point where is forced to undertake a form of restructuring, possibly at the hands of an insolvency expect in order to re-emerge as something completely different.

One possibility is for the ‘new’ Qantas to be a brand manager, supervising a number of low-cost carriers able to compete in different domestic and overseas markets.

What that means is that Qantas unions, in their ham-fisted way, might be walking into a Qantas ambush with dire consequences for union members – though that assumes Qantas management would (a) sufficiently diabolical to plan such an event and, (b) clever enough to execute.

Same old tune

“ECONOMICALLY unsound, convulsed by political struggles, and financially rotten, her condition was pitiable.” Famous words said about Greece, but when?

According to Oliver Marc Hartwich, a research fellow at the Centre for Independent Studies, that was an assessment of Greece in 1901 when the country was a troubled member of the Latin Monetary Union, a 19th century forerunner to the current European Monetary Union.

By 1908, other European members of the Latin union kicked Greece out, tired of its refusal to play by the rules.  Not much changes, does it.

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“In Greece, wise men speak and fools decide.”   

George Santayana


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