What if you actually could make gold from other metals? Gold would be worth about the same as those other metals. Basically worthless. It wouldn’t be rare any more. It wouldn’t be precious.

Yet today we have an economic system founded on this fallacy. Paper money is ‘wealth’ backed by the government. The government employs alchemists like Glenn Stevens and Ben Bernanke to create more money. And that means the whole stock of money is worth less.

Meanwhile, no-one’s printing gold yet. We’ve tried every combination and permutation of every ingredient in our cupboard. None of it makes gold, although with a hybrid of vegemite and honey we think we’ve invented a grand new condiment. No new gold supply though.

Meanwhile, Bloomberg says South African gold production dropped 10% last year. Energy production over there is unreliable. And when it comes down to it, the lack of new gold supply makes it a better wealth-holder than cash. We’d take scarcity over abundance any day. Gold is scarce. Fiat money is abundant.

That’ll become very obvious soon. The failure of Fannie Mae and Freddie Mac is pushing Bernanke and the US Fed closer to a wholesale dollar-printing scenario. But you might not have to wait that long for gold to react.

Demand from the Indian jewellery market hits its stride around this time of year. Or, at least, that’s been the case every year for the last 6 years. Since 2002 gold investors have gotten a 10% Christmas present. Ten percent, on average.

Deck the halls with bullion. But for goodness sake, do it in September.

Last year the September-December surge was 24%. Following that Indian jewelers and worried investors helped take gold to its highest peak ever. The fundamentals of the gold market haven’t changed much in a year. And the price is where we left it at the end of last year, US$800.

The gold companies, however, are a completely different story.

You’d expect big gold producers to track with the gold price. They have, sort of. But in the last month they’ve gone off the rails. With the exception of Newcrest (ASK:NCM), most of Australia’s larger gold producers have lost two years of share price gains. They’re trading at 2006 prices. Back then gold was US$600.

A lot of commodities are cheap now (like our favourite metal for the energy boom). But gold producers have taken the most serious of whackings. They’ve been the scape-goats and whipping-boys for commodity bears.

If you go further down in the gold food chain, things are even cheaper. Smaller gold producers are about as fashionable as a pink mohawk at the Melbourne Cup. Take our favourite Diggers and Drillers gold pick. It’s on sale at 2005 levels. That price implies something even more dire than a US$600 gold price. There’s nothing wrong with the company. It’s selling lots of gold. But it’s at a huge discount.

There’s a point for discussion. When the market for gold equities turns around, what’ll lead it up? Chronically oversold juniors? Or producers with more leverage to gold itself?

We don’t know to be honest. We probably lean towards producers. To ride the gold express you’ll need a ticket. To benefit from a rising gold price, you need some gold. Some explorers ‘might’ have gold. But a lot of them only have patches of spinifex-ridden desert. And even if there’s gold in the ground, it might not be mine-worthy.

Considering that this sell-off hasn’t been completely rational, it’s difficult to tell exactly when it’ll turn around. You can’t predict what a crazy man will do next. He might just keep acting crazy. But we do know that these things turn around eventually. Nothing’s as cyclical as the commodities sector. And gold firms have taken a bigger haircut than most.

Source: Gold is the Oldest Form of Wealth

Chuck Butler says only one more rate cut is likely this year. Charles Delvalle, meanwhile, expects dividends on Austrialian companies BHP Billiton (NYSE:BHP) and Rio Tinto (ASX:RIO) to fall as the Aussie dollar weakens against the greenback.

Al Robinson at The Daily Reckoning Australia says the RBA is caught between fighting higher prices and a stagnating economy. But he says local mining stocks still a good bet…

If you witnessed complete strangers linking arms and breaking into song in the street this morning, it was either a long-lost chorus line or a collection of relieved homeowners. Yesterday the Reserve Bank cut base interest rates for the first time in seven years. If you’re an average Australian, you’re now $44 better off each month. Or $528 each year.

What of all that hoo-ha about Big Banks keeping the cut to themselves? It turned out to be just that. A monumental load of hoo-ha. Within nine minutes of the RBA’s announcement, all four had passed on the savings. Pretty eager. Who said there wasn’t enough competition in the banking sector?

Don’t think the credit ‘crunch’ is over though. This is the downleg of a cycle, not a blip in a glorious, perpetual uptrend as some people seem to think. Kris Sayce at Money Morning spies a dissenter in the market. Wizard Home Loans didn’t lower interest rates. It raised them. Check out today’s MM for the full story, and all your other important market news.

Meanwhile, the economy is blowing a cloud of fog into investor’s windshields.

The first thick layer of mist becomes apparent in Glenn Stevens’ official statement. Here are the two paragraphs to take note of:

The rise in Australia’s terms of trade that has occurred is working in the opposite direction [to slowing growth], adding substantially to national income and ability to spend. Fixed investment spending by businesses continues to be very strong. At the same time, high prices of oil and a range of other commodities have added to global inflationary risks. They are also dampening growth in a number of countries.

Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that household demand will remain subdued and overall economic growth slow over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices.

In plain English, there are opposing forces. The rising Australian terms of trade is bringing money into the economy, fueling it. A higher oil price is adding helium to the price balloon too.

Meanwhile, the credit crunch has smashed investments and caused money markets to flare up. The upshot: higher market interest rates, lower asset values and less spending by John Citizen. Poor Johnny C.

That’s pulling the economy down.

We have consumer price inflation plus a stagnant economy. Stagflation. The two-headed ogre of despair. With its dual maws, it attacks wealth from two directions at once. Rising prices mean Johnny C pays more. A slower economy means he has less wealth to spend in the first place.

Central banks are only equipped with one sword: manipulating cash rates. ‘Sword’ might be a generous term. Maybe butter-knife is better. Anyway, it can’t take out both the ogre’s heads at the same time whether it’s slashing or buttering. So what’s the economic solution?

There isn’t one. Not based on Keynesian, business cycle-smoothing economic policy. Or any other economics for that matter. An economy is a self-correcting system. It’s correcting the low prices and high growth we’ve had for years…with high prices and low growth.

So there’s that first layer of mist. Economists are faced with a scenario they’re not used to. Economic ‘uncertainty’, as Glenn Stevens put it. Hence the fog. How do you invest when the future is invisible?

(If you answered the housing market, go sit in the corner. If you can even afford the rent of sitting in the corner. Investing in unaffordable assets is not advisable. And we see Money Morning has a nice graph of what unaffordable housing looks like today too.)

We’ll get to a real investing solution shortly.

First, we spy a second layer of wisping, foggy uncertainty. A cheaper Aussie dollar. The interest rate cut has slashed over US13c of value from our little gold kangaroos. They’re trading at US83.5 cents today.

Other currencies are giving our dollar the hop too. That’ll only serve to import higher prices from overseas. Australians paying more for things, in other words. The left head of the ogre just grew a little. Which problem should the RBA deal with? Slower growth or higher prices?

Again, this isn’t the kind of thing a central bank is equipped to deal with. An article in The Age down here in Melbourne hinted we might see the RBA switch back to raising rates. Just to keep the dollar up. That’s getting fancy. A cut here, a snip there. A deft dodge, a subtle weave. Now we have a ballet dancer taking on a two-headed ogre with a butter-knife. Eeep.

It’s an absurd suggestion. But it’s evidence that this is a serious dilemma. Absurd suggestions start appearing when there are few good ones. We have rising prices from higher incomes…higher prices from a lower currency…and slower economic growth from high market interest rates. It doesn’t bode well for individuals or businesses.

About that solution. Quickly.

It’s no barnstorming, revolutionary idea. It’s just picking an industry that has the best of this world.

Raw materials companies are Australia’s breadwinner. Undeniably. The RBA’s still worried about ballooning prices. Mainly because mining exporters are still pulling in cash from Asia. Those rising terms of trade are concentrated in a few industries; coal, iron ore, energy, wheat. If the Australian economy is a water balloon that expands and contracts, there’s only one thin straw drawing real, liquid wealth inside. That straw is Western Australia, Queensland, and their natural resource advantage.

It’s the precursor to the inflation that keeps the RBA up at night. Mining earnings. Inflation’s first stop-over in Australia is BHP’s income statement. Unlike John C Citizen, and most other businesses, miners are still making money. Most coal companies locked in double digit earnings growth last month with contracts.

The lower Aussie dollar doesn’t hurt every industry either. China’s basically pegged to the US dollar. As far as Beijing is concerned, Australian coal is US13 cents cheaper than it used to be. So are the coal companies themselves.

And those falling asset values? That’s the key. That’s what makes investing in resource firms timely. Without a broken stock market, miners might still be trading at P/Es double those of today. Buy low.

So Diggers and Drillers will be stocking up on miners this month and next. More than usual.

Source: Reserve Bank’s First Interest Rate Cut in Seven Years

Al says that once the dust has settled on the financial crisis, the industrialization of Asia will return as a key driver of the global economy. This, of course, will be led by China, which could experience a post-Olympic jump as it switches the factories back on after the Games. Al says Australia’s resource sector is a great place to profit from China’s rapid development…

The ASX chases the Dow wherever it goes. Last night Captain America’s stock market lost 242 points. Leading the charge toward oblivion were US financials. Banker Lehmann Brothers (NYSE:LEH) and insurer AIG (NYSE:AIG) took a whacking.

And what ho…this morning BHP (ASX:BHP) and Rio Tinto (ASX:RIO) are down 1.5% apiece.

Australia is a two-sector market: financials and resources. But in a bear market, they cease to be two different sectors. They become the same thing. ‘Stocks’.

The same was true for the US market in the early 1920s. More so. There was no index for the overall market. One each for the two different sectors: railroads and industrials. You could have chocolate or vanilla. No strawberry.

Industrials pulled the whole market up during WWI. Analysts were worried pre-war that Europe would sell US dollars for gold to help finance their war efforts. The opposite happened. Liquidity flowed in. To murder each other more efficiently, European nations needed to tap into the new, American industrial machine. They bought everything America could make.

At the turn of the century, US industrial stocks were worth about 25% of the market. By the end of the war that was closer to 80%. During that time, the railroad-dominated transport index had been up and down. Then the bear of 1919-1921 struck.

Prior to the bear, industrials were industrials. Railroads were railroads. They went up and down for their own reasons. In 1919, they all became ’stocks’.

There was no more discrepancy. The chocolate tasted awful. Vanilla tasted just as bad. Investors spat them both out. Each lost over 40% before the market settled in 1921.

The last year has eclipsed that performance. Pretty much anything with a price tag has tumbled in value at some point, on a global scale. It all went up, bar a couple of dogs like the US dollar. Now it’s all coming down.

The common denominators? Stupidity, ignorance and speculation. Credit booms breed these things. Credit busts help eradicate them.

What we want to know is how the financial mountain-range will look after the snow of speculation has fully melted. Our guess is that the real Everest of the boom (Asian industrialisation) will stand a lot taller than the other, false peaks (banking, real estate, derivatives, stupidity).

On that point, Rio has raised an interesting possibility this week. It reports annual results later today. Expect double-digit profit growth and shameless spruiking of its businesses.

But the big miner gave us an appetiser this morning.

Your Most Honourable Chief Reckoner Dan Denning mentioned the possibility of a post-Olympics slump in China’s economy recently. Something similar to Sydney. A slow-down in the economy as all the tourists and competitors head home, taking their spending money with them.

Best of luck to any athletes travelling Qantas. The swimmers should be fine.

Beijing isn’t Sydney, though. It’s the centre of the world’s third grand industrialisation. And while the country was on show, everything had to look ship-shape. That meant a bit of spit here. A bit of polish there. Shutting down factories that otherwise would’ve spewed pollution into the path of Kenyan marathon runners.

“The Olympics have accentuated the usual summer slowdown in commodities demand,” Rio’s Chief Economist Vivek Tulpule told reporters yesterday. “When activity is allowed to start around – Beijing, there will be a post-Olympics jump.”

There’s the possibility China might have brought the slump forward. That’s food for thought. Sydney didn’t have smokestacks it could turn off prior to the 2000 Olympics. All it had was tourism spending.

But China has more internal demand that it can now bring into play. And it continues to prove that point. The greatest source of its wealth is its own people. Their spending and labour is self- contained. They have little to do with America’s shambles.

China has 1.2 billion people living on incomes of around US$5,000 per year. The average person in a developed country makes over six times that. Catch up, China.

There will be bumps, of course. You can’t grow a country at double- digits smoothly. And there’s always the risk the whole thing could come crashing down in a heap. There’s only so much oil in the ground, after all.

Until that happens we like a couple of metals plays. You’ll find them in the recent pages of Diggers and Drillers.

The first is nickel. We’ll hold off on dropping the full story here. Suffice to say, a lot of the world’s biggest nickel mines are getting a mite expensive. That’s putting a new floor under the nickel price. Want a closer look at the nickel market right now for free? Pop on over to Money Morning. Gabriel Andre has a few words for you.

But we don’t mind telling you about the other play in full. We’re out of time today. You can read the full report sometime in the next 48 hours. Keep an eye on your email inbox. And tomorrow we’ll find out exactly what Rio has been up to in the past six months.

Source: China’s Economy Could Experience a Post-Olympics Slump

Officially, producer prices rose 1.0% in the June quarter. Hmmm. Here’s 3.03 cheers for making stuff.

But it’s still a good result for the manufacturing sector. Commsec, for example, was predicting growth of 2.0% for the June quarter. The economy pulled a fast one and stopped buying.

The important thing is, if the producer price index is a prelude to a lower consumer inflation release on Wednesday, you might get that bounce in the ASX after all. The slightest prospect of an interest rate cut sent investors into bullish acrobatics yesterday. They did handstands until the close of trade. The All Ordinaries added 3%.

Note that those handstands are based partly on the assumption that the producer price index is linked to consumer prices. That the cost of production finds its way through to retail prices… so that consumers can enjoy the same inflation as manufacturers.

A lot of people are expecting consumer inflation to follow producer inflation’s lead.

That may or may not happen. But here’s an interesting point. This is the official release about the June 2008 producer price index. Take a glance at it. According to the ABS, the only items to actually fall in price were agricultural goods and electronic equipment. Everything else got more expensive. Especially fuel…refined petroleum rose in price by 8%.

If the fall in food prices filters through the economy, you get a bit of short term relief at the fruit and vegetable aisle later on in the year. And if the oil price continues dropping, there’s a good chance petrol might drop off too.

Prices, it seems, have risen enough for now. Inflation will be back, we suspect. And don’t rule out a surprise in the consumer price index release on Wednesday. But at this point, the economy could use a rest. Hopefully it’ll get one. If the CPI numbers come in at ankle-height too, shares will go up. That’s our prediction.

So that’s what shape the economy is this morning. There aren’t as many sharp corners on it as experts expected. And Energy prices haven’t moved a whole lot this week. Oil is still trading at about US$130. But there’s one other ‘E’ that we reckon is driving the sharemarket… Earnings results.

Al Robinson
The Daily Reckoning Australia

Source: June Producer Price Index Indicates Slower Inflation in Australia

Not just coal though…coal seam gas. Black rock is the new black. Rock on.

We emailed our full wrap-up of the sector to our beloved Diggers and Drillers fraternity a couple of days ago. But the big-wig of the sector is Santos (ASX:STO).

Santos, after wooing several potential partners, has found a mate to invest in its LNG export terminal at Gladstone. Petronas, Malaysia’s state oil and gas investment vehicle, grabbed 40% of the project for AU$2.6 billion. Santos must have laid the woo on pretty thick.

But woo is an infectious disease in the hard asset sector these days. You have to wade through a viscous slurry of woo to get anywhere. Romance is blossoming…covetous, greedy-eyed romance. Everyone wants someone else’s stuff.

How else could Australia’s largest sugar producer make 38% of its revenues from building products…35% from aluminium…and just 19% from sugar? It’s been doing some whacky diversifying.

Whacky or not, Gabriel has caught the sweet scent of gains in CSR’s (ASX:CSR) chart. As usual, you’ll find him toiling away down at the bottom of the e-letter.

This new Santos story opens up another door for coal-seam gas producers. BG’s bid at the start of this month was like connecting a jumper lead for stocks with coal-gas. Petronas’ foray will shift share prices up a gear again. Two of the world’s largest LNG producers have thrown their back into Australia’s top-notch coal-seam gas reserves. If they play this right, the stuff should be whizzing out of port and up to China within a few years.

How good is that demand source though?

Huge Growth in LNG Demand

Well, latch your peepers onto this offering from ABARE. It shows you what LNG demand is capable of doing in the next few years. LNG is as good as any fossil fuel, but it’s one of the cleaner ones. So it’s getting top billing these days.

Growth just keeps popping up in the energy sector. A thought hit us late yesterday on the topic. We think the oil price is too hot to touch right at this instant. Further down the track, it’ll be a little cheaper.

But when it comes back a little, that doesn’t mean things go back to normal.

The current spike in oil prices tells you something. No-one has full control over the oil price. The purpose of OPEC in the first place was to keep oil between US$22 and US$28. Obviously it didn’t keep it there.

She asked if anyone had cold feet. Our hand shot up. Our legs shot out. Our shoes flew off. Fate took its course.

Apart from our new found foot-warmth, something else is giving us a warm glow today. The coal boom isn’t over yet. You haven’t missed it. That’s reason to celebrate. A Lleyton Hewitt-style show of fist-pumping bravado might be in order.

Coal prices might be staying higher longer than anyone expected.

Dalrymple Bay terminal is one of the largest coal ports in the world. It can ship 65 million tonnes of coal in a year. That isn’t enough to feed all of China’s coal power plants. But it makes Dalrymple a focal point for Queensland’s coal production.

Babcock and Brown, infrastructure owner and not much else these days, owns the port. It heralded an ambitious expansion at Dalrymple last year. By December, total capacity would be 85 million tonnes.

Funny thing, ambition…

It won’t happen. That’s not Babcock and Brown’s fault. Rains came. Builders languished. The new expansion will be finished in March at best.

That means supply of coal to China will be a few million tonnes shorter than investors expected. That may not sound like much. China’s imported 51 million tonnes of coal last year. Who gives a hoot about an extra 3 million?

We do. We give many hoots. We’ve got a truckload of hoot coming your way. We’ll explain why in a minute.

First, a key point. We were surprised to find that Newcastle, Australia’s other big coal port, just announced an 18% fall in shipments. You’d think coal producers would be swarming the place while Dalrymple’s full.

There’s nothing wrong with Newcastle. But the same rains that hit the port in Queensland delayed the miners themselves. They simply don’t have the coal to ship.

The grand new coal expansion is certainly having a few teething problems.

Now…the important part.

This is a marginal situation. Marginal situations are a type of investment idea that often escapes the average person’s attention. They don’t look particularly enthralling on the surface. But everything happens at the margin.

A premium example is Saudi Arabia’s oil production. The world uses 86 million barrels of oil per day. Saudi Arabia produces around 9 million. It’s special because it has the ability, although limited, to add new production. Most other countries are running at full capacity.

The world oil market is stretched tight, like a fitted bedsheet on an expanding air-bed. But the bed is growing as more Asians buy cars. Saudi Arabia may be the only corner of the sheet left with any give.

But here’s the thing… it doesn’t need to add millions of barrels of new oil to have a significant affect. It announced an extra 350,000 barrels yesterday. That’s only 0.4% of world oil demand. Tiny. Miniscule. Marginal.

Well, the oil price fell US$3. More on that below.

You see, it doesn’t take a lot to move a tight market. So if China misses out of 3 million tonnes from Dalrymple Bay when it wants 50 million overall…that’s quite a lot.

Website Globalcoal keeps indexed prices of coal. It also keeps track of the prices at major ports like Newcastle. They’ve all had big movements in the last couple of weeks. One index shifted 14%.

The short story is that coal prices may just keep rising. It’s not too late to invest here. It’s still a hot asset. And there just isn’t enough of it. That’s the kind of asset you want to hold.

Curious. How could that be?

It’s an interesting story. Glad you asked.

Saudi Arabia runs its oil operations like a family Italian restaurant. In theory, everyone owns a bit of the business. There aren’t private interests like Santos (ASX:STO) or Woodside (ASX:WPL). Aramco is Arabia’s oil producer. The profits from oil then go to the government.

Of course the last link in the chain, where the government transfers money to its people, is usually missing.

But Saudi Arabia is a lot richer than it used to be. As we said in a previous Money Morning, at US$130 it pulls in revenues of well over a billion dollars a day. And that means it has spare liquidity to pour into investments. Those investments will, of course, be the source of its income when oil eventually runs out.

One of them is Australian. Bemax Resources (ASX:BMX) recently received a takeover offer from Arabian National Titanium Dioxide Company. Bemax burrows around in Australia’s vast mineral sand resource. Among other things, it produces minerals containing titanium and zircon.

As Dan Denning notes in a recent Australian Small-Cap Investigator, these metals are getting a lot of demand from ceramics industries. He’s put a magnifying glass to the whole sector. It doesn’t seem like anyone else has heard of the potential here. We’d thought you’d be interested. Foresight here could be very profitable indeed.

So Arabian National Titanium put up a AU$300 million takeover offer. Bemax is already up 35% this week. It’s one way Saudi Arabia is expanding and diversifying its economy to prepare for post oil-boom times.

Sinosteel Regroups for Another Billion-Dollar Iron Bid

It’s often how a person acts, not what they say, that shapes your opinion of them.

The politician who promises to lower taxes? He’s too busy splurging on an electoral campaign. The fellow in the pub who tells you he’s “sober as a judge”? A judicial authority is rarely found sprawled upside-down under a bar stool, attempting to woo a disgusted member of the opposite sex.

Actions talk. Talking doesn’t always mean action.

As you saw yesterday, Murchison and Midwest look set to wed in corporate matrimony. But let’s consider the actions involved. How did China’s Sinosteel respond?

It went straight to the Foreign Investment Review Board.

Why?

To argue that it wouldn’t have to re-apply for approval, now that its target will probably become a new entity. There’s only one reason it would keep that option open. It plans to make another bid.

This time, the stakes have risen. Murchison just announced five-fold growth in its iron mineral resource. Add in Midwest’s resource. The company now controls over 600 million tonnes of iron, in various forms. It’s all quite close to important shipping ports.

To China, this means more iron under one roof. So it has popped down to the realty to see if this new house is for sale.

We’re surprised it found the time. Sinosteel has been very busy working on a stake in Fortescue (ASX:FMG) lately. The iron-hungry steel maker has been soliciting Harbinger Capital for its 8% stake in FMG. Fortescue leapt 7% yesterday. It’s now a AU$27 billion company.

We don’t need to spell this out. Sinosteel wants to own an Australian iron exporter, one way or another. We have a feeling it’ll get its way.

ABB Grain Adds 80% to Profits

ABB Grain (ASX:ABB) just unleashed some déjà vu upon us. A week ago AWB (ASX:AWB) announced a 90% boom in profit growth. Yesterday ABB did a good impersonation, revealing an 80% boom in earnings. The company’s share price added 8%.

Wasn’t the market expecting something along these lines? Grain prices soared earlier in the year. It’s been a good growing season. Maybe people are only just starting to wake up to the agricultural boom.

If that’s the case, you might be interested to know that Graincorp (ASX:GNC) is yet to announce any new profit guidance for this year. Maybe it’s next in line. The company expanded its grain marketing operations in 2006-07. And as you can see below, its share price hasn’t curved up in the recent past.

That’s probably because the stock is bidding for Ridley Corporation (ASX:RIC). The market may have overlooked this one.

If you’re not exposed to rising agricultural earnings yet, it might be time. And if none of the companies above suit you, we have two even better suggestions.

We know you might prefer to sample something before committing to it. Fair enough; we’re the same way. So we’ve twisted our boss’s arm a little. Diggers and Drillers is now offering a 3-month trial subscription. Take a look at the link for our top two picks in the Ag sector, plus all our currents “buys” in metals, coal, iron, oil and gas. If you don’t like what you see, no problems. It’s only a trial. The next issue comes out later today.

We’ll be looking at others soon. Until then…

Al Robinson
The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Source: Saudi Arabia Pours Oil Investment into Australia

So, this morning, we write to you in a puddle of our own regret. We lacked foresight, and water-proof pants. We’ll try to exhibit a bit more of it as we map out where the money is today (foresight, not water-proof pants).

Foresight, of course, is a quality everybody wants and nobody has. Who couldn’t do with a little more of it? It’s one of those constants that you always need to constantly invest well…foresight, hard work, patience, a bit of luck here, some good timing there.

Meanwhile, the only news that matters in Australia today seems to be takeover-related…

Western Juniors Could Create 4th Biggest Iron Player in Australia

Here’s some foresight. Investors who jumped on the iron ore train are getting their dividends. Yesterday Murchison Metals (ASX:MMX) gave iron cousin Midwest (ASX:MIS) an all-share merger offer worth . The market loved it. Midwest leapt 12.3%. Murchison flew 8.3%.

Everybody won, except Sinosteel. The Chinese giant was closing the net around its prey, Midwest. The nerve of another prey to go and outdo it.

Together, the two iron diggers would have a market cap of AU$3.2 billion. That’s bigger than Portman (ASX:PMM), Mount Gibson (ASX:MGX) or the other second-tier contenders. It’d leapfrog the companies up to fourth place in the industry, behind Fortescue (ASX:FMG).

The structure of the deal, though, tells you a little more about the whole matter.

Sinosteel already has 19.9% of Midwest. That’s the maximum you can own without bidding.

In a direct response to the stake, Murchison has proposed a reverse-takeover. It has offered itself up as a sacrifice to the deity of iron ore. Under Australian corporations law, a reverse-takeover means the deal only needs 50% acceptance from Midwest shareholders to go through. Otherwise, a standard takeover would’ve meant a minimum of 75%.

Ergo…the two do not want to be bought. Not by China. Not at any price near what Sinosteel is offering. The Australian iron sector is combatting external consolidation with internal consolidation. Both mean share prices are going up. Here the five top juniors’ performance this year. They’ve made gains of between 21% and 65%.

Midwest’s management has recommended that shareholders accept the deal. You’ll find out in the next three months what they think of it.

You’ll also find out exactly how desperate China is to get its paws on our iron. The ball’s in your court, Sinosteel. The company will most likely withdraw, and reassess. Perhaps it’s content to pay huge spot and contract prices for iron in Asia. Or perhaps it’d like to own the next best producer after Fortescue.

St George Accepts Westpac Bid…Almost

A much bigger takeover is slowly plodding towards the finishing line. St George (ASX:SGB) signed a scheme of agreement with Westpac yesterday. It had prudence enough, though, to add some fine print to the contract. We’ll do a deal you, Westpac. As long as your shares stop dropping

So far, Westpac’s bid is 10% smaller than when it came into the world. The stock is at a year-low. If the fall that began last week in the All Ordinaries accelerates, Westpac’s shares may continue to erode. Maybe the finishing line is a little further away than we thought.

Two takeovers are evolving parallel to each other. There’s the iron story in the hard-asset market, and the banking story in the financial sector. Both are mergers, involving shares only. No cash. Analysts tell us that the prices are good. Yet the parties involved have reacted entirely differently.

Midwest said “Yes” and left it that. St George said “Maybe. Just don’t let your share price fall.”

Sadly, Westpac doesn’t have a lot of control over that. And those two reactions might reflect the underlying businesses, we reckon. Iron ore miners are willing to jump on the front foot. They’re merging to create more scale in a growing industry. Banks are on the back foot. They’re merging as a defense against falling earnings margins.

Westpac’s interest margin has fallen from 2.6% in 2003 to 2.25% last year. It won’t have improved since the last report, filed in November. Bankers aren’t making as much as they used to. That’s the bottom line. There are better companies to invest in.

Al Robinson
The Daily Reckoning Australia

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Source: The Fourth Biggest Iron Player in Australia

Of course, financial companies have assets. But they’re not tangible things. You can throw a rock at your neighbour’s window, and it’ll shatter. If you threaten to throw a mortgage-backed asset at your neighbour’s window, he’ll probably run shrieking out his own front door all the same. But the window won’t break. Securitised assets can’t be thrown, no matter how much misery they’ve caused.

Real tangible assets are in a bull market at the moment. A non-imaginary one. The values of commodities can be identified in real markets. There are real people buying these things, and transporting them to real countries in real ships. They crush them and cook them with real machinery, then sell the refined product to a real end-use.

We may very well see a bubble develop in the commodities boom soon. Anywhere where there’s a good opportunity, greed and opportunism follow. But the real nature of this boom is what sets it apart from booms in technological speculation or financial earnings.

Now here’s the important part…what happens now that the mining sector is the undisputed leader of the market?

Could this be a symptom of the much-maligned “decoupling” theory?

Commentators slaughtered the idea last year. The Aussie market fell just as fast as the US. Indeed, global equity markets fell in unison. But that was when the Aussie market had finance as its lifeblood.

Since then, trade with other countries has increased. Our five top exports are all resource offerings. Iron…two types of coal…oil…and wheat. There are no securitised assets or government debt on that list. Just useful things.

A true decoupling can’t happen yet. That would, among other items, require a major overhaul of the international currency system. But a-mini decoupling of sorts is already happening in the Aussie economy. Every time we export more iron to China, we have a little less to do with the US economy.

Chinese Wheat Production Hit by Disease

China’s National Bureau of Statistics says the country’s largest wheat-producing province won’t be breaking any records this year. Henan Province is facing disease, not to mention rising costs from oil and fertiliser booms.

Woe, woe, woe…

It’s a disconcerting fact that agricultural production today is an oil-based business. We turn natural resources into food. Petrol fuels the massive machinery that mass-production farming requires. Phosphate, potassium and nitrogen make up the chemical fertiliser that stimulates extra returns on crops.

Rising prices wouldn’t so much of a problem if Chinese farmers could make up the difference with a good year. But pests are making the situation harder. ‘Sharp eyeshot disease’ is expected to take its toll on Chinese wheat fields this year.

As we said earlier, wheat is one of Australia’s top exports. If China can’t get enough wheat, it’ll look to us. Now that AWB (ASX:AWB) has lost its grip on the exporting trade, a few second-tier wheat players may be worth a look…

Gold in a Good Place for Buying

If money’s moving out of stocks, where will it go?

It might be time to take another look at the ultimate alternative, gold. It hasn’t made a major move since it came back from US$1000. Gold costs US$920 this morning. Our hunch is that that’ll change in the next month or so.

Al Robinson
The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Source: Chinese Wheat Production Hit by Disease

The chart is below, click on it to see it full size.

Click on the image for a larger version

Queensland’s coal industry has never had it better. Yet one of the ironies of the recent rise in contract thermal and metallurgical coal prices is that coal producers may not be able to take advantage of them this year.

If you missed the news, thermal coal prices for 2008 more than doubled from $50 to $130. Meanwhile, the 2008 contract price for coking coal used by steel makers tripled, going from $80 to $300.

Unlike more widely traded commodities such as oil and copper, the prices for coal (both thermal and metallurgical) and iron ore are set in annual negotiations between major producers and consumers. The major producers are the large mining companies. Those include BHP Billiton, Rio Tinto, Xstrata (in coal), and Value (in iron ore).

The major consumers for thermal coal, used to heat boilers for steam-generated turbines and electric power, are Japanese Korean and electric companies. The relationship between these companies and Aussie firms go back all the way to the 1960s, when Japan and Korea began their post-war industrial growth spurts. For steel, the major consumers of Australian metallurgical coal and iron ore are Japanese, Korean, and, of course, Chinese steel makers. China is the world’s largest steel-producer (and consumer).

The price rises should be good news for Aussie producers. The trouble, at least in the coal business, is that bad weather and infrastructure bottlenecks are making it harder for Aussie firms to increase production volumes this year. You can’t sell what you can’t get to market.

So while export earnings for Aussie resource producers will be up this year because of the rising coal price, actual production volumes will not increase. As evidence, consider the first quarter production figures from Rio Tinto earlier this month. Rio’s coal operations are in the Bowen Basin of Queensland. That area was subject to heavy flooding in the first quarter. Coal production fell by 27%.

So who will benefit from the rising contract prices? The short answer is that coal mining service companies probably will. For the coal producers to expand production, they will to invest in mine expansion and infrastructure. In Queensland, where many of the mines are underground, that means work for the specialist firms that help build underground mines. Stocks to watch in the sector include:

1. Walter Diversified Services (ASX:WDS). According to the company, “Walter Diversified Services Limited (WDS) is principally engaged in the provision of specialist services to the underground coal mining industry, and to the infrastructure oil, gas and water pipeline construction and maintenance sectors in Australia.”
2. Whitehaven Coal Limited (ASX:WHC). Whitehaven actually operates several open-cut coal mines in New South Wales. But the company, which is really a group of companies, also mines and sells metallurgical and high grade thermal coals
3. Cockatoo Coal (ASX:COK) Cockatoo isn’t producing any coal yet. But it’s involved in four projects in Queensland, the Wonbindi project, the Dingo Coal Project, Guluguba and Mintovale. Cockatoo’s are in Queensland’s Surat coal basin, with slightly lower quality than the Bowen Basin coal. But as they are unmined, when production commences the company will be able to take full advantage of higher contract prices.

Another development to watch for? Coal-to-liquids (CTL) production of diesel fuel becomes economic with high crude oil prices, especially in areas where “stranded coal seams” are not large enough to mine economically as conventional coal. Those stranded seams now have to new routes to energy viability.

We covered one Aussie company engaged in the CTL business late last year in the Australian Small Cap Investigator. We suspect that there may more like it soon, if current events are any indicator.

Al Robinson
for The Daily Reckoning Australia