Why a ‘no’ from New York counts

Four years ago, only a handful of people believed that the world was heading into a resources boom. Today, only a handful believes that this phase of the boom is running out of puff. But, if you look closely, warning signals are appearing and a wise man might be preparing for a correction – not a crash, but a correction with the potential to be very painful.

The latest signal to catch the eye of Briefcase was the reluctance of New York-based investors to support two big resource-related capital and debt raisings.

Two weeks ago, the major shareholders in Phelps Dodge, one of the world’s biggest copper miners, told management that they would not support a high-priced attempt to acquire the Canadian miners, Inco and Falconbridge.

Last week, North American investors failed to support an attempt by another big miner, Teck Cominco, to raise $6 billion as part of its attempt to acquire Inco.

The failure of one big capital raising is not news. Two is.

In the space of a few weeks some of the world’s richest people have told the managers of their funds, ‘no more’.

The question is why? What do the smart-money people of New York know that is eluding people at the epicentre of the boom; such as the people of Perth.

In one word, the answer is ‘knowledge’. In two words, it’s ‘collective memory’. They have seen repeated booms and learned the hard way how to avoid what comes next.

Investors with serious money, and who live close to a concentration of information from around the world, such as in London and New York, are sniffing the breeze, and taking evasive action to prevent catching the financial equivalent of the flu.

True, some have supported the $2 billion junk bond raising of Fortescue Metals. But anyone who took up that offer with its 10 per cent interest rate are speculators, not investors, and they will probably get what they deserve.

Genuine investors, as opposed to those simply seeking a high yield (in the ‘any-yield will do’ category) can see the pincer-squeeze on consumers around the world from sky-high oil prices, and rising interest rates. Even if both oil and interest rates have stopped rising, these twin forces are now doing their job – crushing demand for goods and services.

In Perth, with so much capital committed to resource development projects, combining with a property boom, and the fastest-growing salaries in Australia, there is a surreal disconnection with what’s happening elsewhere – even with those foreigners in the eastern states who are not enjoying the same benefits of the boom.

Oil-related business will be less affected than most when the correction bites. But companies, and investors, exposed to other resources are well advised to prepare for a slowdown.

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Commodity prices are the key to what happens next, but before taking a squiz at the latest ‘best guesses’ from a local guru, take the time to have a closer look at the Teck and Phelps failures.

In both cases the ‘winner’ in the takeover stakes was a company slightly disconnected from the pressures of the real world, especially from the prying eyes and probing questions of well-informed, and well-armed, investors.

Teck, it seems, has been beaten to Inco by the big Brazilian, CVRD, a company answerable in the final analysis to the government of Brazil because the chaps in some obscure ministry hold what is called a ‘golden share’ – a form of ultimate veto over the business.

For management, a golden share held by government is a licence to do what it likes. Or do nothing. CVRD management, which includes very slick, New York-trained investment bankers, is doing what it likes. In another example of a golden share at work, management at the Adelaide-based oil explorer, Santos, opted to do nothing for 25 years, until a new team was swept to power about five years ago.

Phelps, it seems, has been beaten by Xstrata, a big Swiss-based company effectively controlled by the nameless gnomes of Zug, home of the Glencore commodities trading business, which has its foot on 40 per cent of Xstrata’s capital.

It could be argued that both CVRD and Xstrata are playing the long game, assuming that China-driven resources demand will keep commodity prices high.

In the long-run, they are probably right. The trick is judging how long is that run – while never forgetting that in the long run we’ll all be dead.

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Now for the best guesses. This week they come from the chaps at Goldman Sachs JBWere, presumably with a lot of input from the New York head office of Goldman.

Iron ore, the commodity that’s doing as much as oil to drive the WA economy, is perhaps in the final stages of its boom.

According to Goldman, the next round of price setting with Asian steel mills will involve a price downturn of around 2.5 per cent. That’s not a lot after three boom years, but down nonetheless and perhaps the start of a trend, with the price a year later tipped to drop by 9.1 per cent, leading up to a whopping 24.5 per cent drop in 2009.

Optimists looking at those projections will say they do not wipe out the terrific recent gains, such as the 71.5 per cent price hike in 2005.

Pessimists will point out that a lot of the price increase enjoyed in ’05 and ’06 has already been lost to soaring construction and operating costs.

The price of most other commodities, according to Goldman, will also trend down over the next few years. Copper will come down with a bang from $US3.50 a pound to $US2.10/pound. Nickel will drop from $US9/lb to $US6/pound, and coking coal will fall from $US125 a tonne to $US74/t.

The new forecast prices do not mean a sudden plunge into the red ink for most producers. Nickel at $US6/pound is still handsomely profitable.

But they do mean that the bumper profit season is drawing to a close – and that’s why the smart-money of New York walked from the Teck and Phelps fund raising attempts, leaving the way open to CVRD and Xstrata, which have the luxury of playing the ultra-long game.

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“Advice is seldom welcome, and those who want it most always like it least.” Lord Chesterfield