“China also bought 590,000 tonnes of aluminium, 159,000 tonnes of zinc, 30 tonnes of indium and 5,000 tonnes of titanium, said Yu, who works in the National Development and Reform Commission’s industry department.” Now that metals prices have rebounded, though, will the stockpiling continue, even at high prices? Or was it a case of bargain shopping at everyday low prices?

There are several components of demand. There’s real economic demand (you need the stuff to make other stuff). There is investment demand (you’re buying it in order to make a profit from what you think the price trend is. There is also pure speculation, and it’s possible that some middle-men were flat-out speculating by buying alongside China’s State Reserve Bureau (sort of like the banks and brokers in the U.S. buying Treasuries ahead of the Fed late last year to improve Q4 earnings).

But if you’re trying to figure out the ultimate direction of certain base metals prices (or commodity prices in general) you have to also consider the currency in which they’re priced. Or, as my colleague Dan Amoss writes, “You also want to consider what Ben Bernanke and Tim Geithner will do to debase the dollar in the coming years. If you’re a foreign creditor facing with this constant portfolio decision, which has higher marginal utility? Is it 1.) US$2.32 or, 2.) one pound of copper?”

Dan is referring to a pretty handy economic concept. Marginal utility is the economist’s attempt to quantify how much satisfaction or benefit you get out of each additional good or service you buy. You have probably heard the term “diminishing marginal utility” more often.

An easy way to understand this is that while one cheeseburger may satisfy your appetite (and your craving for animal fat), four cheeseburgers gobbled down in a row are neither useful nor terribly good for you. They might even be bad (although as an American, we are reluctant to concede this point).

In Dan’s scenario, U.S. dollar holders will ask themselves if each additional dollar owned is more useful. Given the fact that the U.S. monetary authorities are making so many dollars, it’s pretty clear that each additional dollar added to supply makes each existing dollar less useful. It is not very satisfying to see a methodical reduction in the purchasing power of your savings.

If Dan is right, then stockpiling real assets (even during a relatively weak economy) makes more sense that stockpiling U.S. liabilities. Or, as Dan says, “The Chinese will probably go with #2, especially because copper (and oil, and iron ore) can be stored and used in infrastructure projects to keep the population somewhat placated with infrastructure jobs,” says Dan.

He adds that you should look for the Chinese to stockpile resources on the dips in commodity prices, while selling/divesting of U.S. Treasuries into the rallies that come with ’safe-haven’ buying. That sounds right to us. But the only catch to the plan is if Treasuries fail to rally on safe haven buying.

On that score, the Treasury market seemed to survive last week’s big auction without a huge spike in yields. If the economic news remains neither bullish nor exceptionally bearish, then we reckon Treasuries could rally (prices up, yields down), providing a discrete exit opportunity for certain large investors.

Incidentally, we still haven’t seen much in the Australian press about the long-term consequences of government deficits. That’s probably because most people are accepting the government’s case that Australia’s borrowing (and its deficits) will be temporary. We’re not as sure. And besides, there are some serious questions about how structural deficits affect a country’s currency, its credit markets, and its interest rates.

Those are just some of the questions we hope to take up at our upcoming debt symposium/summit, which will precede the first Australian screening of I.O.U.S.A. We’ve even picked a date, booked a venue, and secured a cracking panel of experts to train their eye on Australia’s very own addiction to debt. Stay tuned for your official invitation!

Meanwhile, did you see that China has astonishingly and rather conveniently discovered some 3 billion metric tonnes of hematite and magnetite iron ore? It’s apparently true, and probably comes in pretty handy during the current stagnated annual price contract discussions with Aussie iron ore producers BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RTP).

As you know, China is the world’s largest steel maker and thus the largest importer of iron ore. Chinese geologists claim they have found Asia’s largest iron ore deposit ever in Benxi city, which is in the northwest province of Liaoning. The good news is that the deposit is said to be about 2.5 miles long and 1.8 miles wide and could, officials say, have a mine life of 50 years-if a mine is built.

The bad news is that the resource (not a reserve because it’s not know if it can be produced economically) is buried around a mile underground. That’s a long way down, or a long way to lift iron up, if you prefer, and if you’re strong (which China is).

Contrast that with the Pilbara, where the stuff seems to lying around waiting to be found in the hundreds of millions of tonnes by any Tom, Dick, or Kerry. That’s right. Iron Ore Holdings, owned by Kerry Stokes, told the ASX yesterday it was increasing by 50% its estimate of its mineral resource at Iron Valley in Western Australia.

This deposit is only 97 metres below ground. It’s surrounded by big projects by BHP, Rio, and Fortescue (ASX:FMG). And the company says it reckons its sitting on a 132 million tonne resource-which is up from the 88 million tonnes it believed it had just three months ago.

Proving up a resource into a reserve-and seeing your share price benefit because of it-is the name of the game for the iron ore juniors. Despite the big Chinese find, we reckon the Iron Valley story is where the Big Picture meets the Little Juniors (or where the rubber meets the road, if you prefer).

At the right prices, stockpiling commodities makes sense to people who will need them later anyway and already have too many U.S. dollars. And if prices aren’t right…if..in fact…commodity prices decline (either because of slow economic growth or a halt in stockpiling) then commodity stocks probably fall a bit too…which makes those very stocks-especially the smaller ones that need capital and JV partners-the next logical candidates for acquisition or accumulation.

Dan Denning
Source: China Has Stopped Stockpiling Metals

The move surprised many analysts, as it will make it easier for Western countries to prevent Chinese companies from acquiring overseas targets and discourage other large corporations from pursuing mergers in China.

China’s Ministry of Commerce blocked the deal saying the biggest takeover of a Chinese company failed to meet the country’s anti-monopoly law and would be “negative for competition.”

“If the acquisition of Huiyuan went into effect, Coca-Cola is very likely to take a dominating position in the domestic market and the consumers may have to accept the high price fixed by the company as they don’t have more choices,” the Ministry of Commerce said in a statement.

Huiyuan Juice is a household name in China, and controls 42% of the country’s pure-fruit-juice market. Coca-Cola controls 54% of China’s soda market.

Coke could challenge the ruling under Article 53 of China’s anti-monopoly law, but the company said in a statement that it would not pursue the deal any further.  “We are disappointed, but we also respect the Ministry of Commerce’s decision,” said Coca-Cola Chief Executive Officer Muhtar Kent.

Coke launched a $2.4 billion bid for Huiyuan Juice last September. At HK$12.20 a share, the deal valued Huiyuan at a 195% premium to its market value prior to the offer. Indeed, the offer was so generous, that some investors thought Coke might actually be overpaying.

Huiyan stock was suspended 13 minutes after trading started on the Hong Kong exchange. The stock plunged a record 19% to HK$8.30 a share during that time.

Implication on China’s Overseas Acquisitions

Analysts were surprised that authorities blocked the deal, which had few economic implications and posed absolutely no threat to national security.

“This seems to me to be against China’s best interest,” Chris Ruffle, Emerging Markets Director at Martin Currie Investment Management Ltd. told Bloomberg. “It plays into the hands of protectionists who will not find it easier to block acquisitions which Chinese companies make overseas.”

Aluminum Corp. of China Ltd. (ADR: ACH), also known as Chinalco, is already facing resistance in Australia, where the company is trying to finalize a $19.5 billion tie-up with Rio Tinto PLC (ADR:RTP).

Australia’s Foreign Investment Review Board is considering the deal amid political opposition that doesn’t want to see key mining assets fall into foreign hands.

Under terms of the agreement, state-owned Chinalco would pay $12.3 billion for a piece of Rio’s iron ore, copper and aluminum mining assets, and $7.2 billion for convertible notes that would double its stake in Rio to 18%.

“I think we should be selling the milk, not the cow and in this case, the minerals, not the mine,” independent senator Nick Xenophon said Wednesday on Australian radio.

Senator Barnaby Joyce, an Australian politician who took out television ads on Tuesday urging the blockage of the Chinalco deal, Reuters reported.

“The Australian government would never be allowed to buy a mine in China. So why would we allow the Chinese government to buy and control a key strategic asset in our country,” the ad said. The ads aired in the capital of Canberra and Joyce’s home state of Queensland, where Chinalco will mine new assets.

Chinalco’s bid for Rio Tinto is just one of many overseas acquisitions being made by Chinese companies, as the nation scrambles to lock in long-term supplies of resources at low prices.

In February, China Minmetals made a $1.7 billion (A$2.6 billion) bid for OZ Minerals (ASX:OZL), the world’s second leading zinc miner. Hunan Valin Iron & Steel Group Co. quickly followed that deal with an agreement to buy $793 million (A$1.2 billion) worth of shares in Fortescue Metals Group Ltd. (ASX:FMG), which has significant iron ore holdings in Australia’s western states.

In February, China Minmetals made a $1.7 billion (A$2.6 billion) bid for OZ Minerals Ltd., the world’s second leading zinc miner. Hunan Valin Iron & Steel Group Co. quickly followed that deal with an agreement to buy $793 million (A$1.2 billion) worth of shares in Fortescue Metals Group Ltd., which has significant iron ore holdings in Australia’s western states.

“I think the Coke decision will backfire on China,” an unidentified dealmaker told the Financial Times. “It will embolden nationalists in countries like Australia, who are unhappy with all these resource deals.”

Source: China Blocks Coke’s Bid for Huiyuan, Jeopardizing Resource Deals in Australia

Asciano has $4 billion debt on the books (much of it inherited from when the company was spun from Toll in 2007). But yesterday the company assured investors it wouldn’t be beefing up the equity on the balance sheet with another dilutive capital raising. And chairman Tim Poole told investors earnings were in line with forecasts.

The trouble is that with all that debt and, shall we say, challenging business conditions, investors aren’t convinced the equity in the company is worth anything anymore. This explains why the Citigroup analyst suddenly shifted from a discounted cash flow model of valuation (which focuses on the present value of future earnings) to an enterprise value model.

An enterprise value model adds up the market cap and debt a company has, and then subtracts cash and cash equivalents. It’s not quite the liquidation value of a firm. But it IS, generally, what it would cost you to take over the company and its liabilities, minus its cash.

So why switch valuation models in mid stream? Well, one reason is that you’re looking for any reason at all to get out of a stock, and one valuation model suggests a much lower share price than another, so you use it. But let’s assume the switch in valuation models is based on new and different business assumptions. What are those assumptions?

Well, if you’re taking your eye off earnings two and three years down the track, it means you think there are much larger immediate business concerns that affect the value of the firm. One of those might be access to capital. If a firm like Asicano has to rebuild its balance sheet by raising new capital on the equity markets, that dilutes existing shareholders.

But really, using an enterprise value model as the justification for selling a share means, as an analyst, you’re throwing in the towel on the business itself (not just the management or the balance sheet). It means you think being in the ports and rail business during a contraction in global trade is a lousy business, with zero earnings power going forward. The fact that Asciano has so much debt during a credit crunch certainly doesn’t help.

The challenge for resource investors now is to sort out which model to use for valuing over sold shares. For most resource companies (the non producers anyway) discounted cash flow models are pretty useless. The earnings are highly variable and cyclical for resource shares because commodity prices themselves shift.

Changing commodity prices affect the ebb and flow between supply and demand. If you asked us, we’d say low commodity prices are already leading to a tightening in supply. In addition to BHP, Rio, and Fortescue idling expansion and production plans in the Pilbara, Alcoa has shelved its expansion plans for its alumina refinery south of Perth. High-cost producers are already being forced out as well. What does all that mean?

It means the credit crisis and the deleveraging in the commodity markets in 2008 are going to lead to lower supply of key commodities in 2009. That lower supply, so far, looks like it will be enough to meet the lower demand that’s been brought about by the global recession/depression.

But it also leaves the surviving players in the resource patch in an enviable position. They tend to have cash. They tend to have lower debt/equity ratios. They tend to have better projects where ore grades are higher and costs of production are lower. And the really good ones have poly-metallic ore bodies, a sort of geological diversification that allows them to shift production to those metals with the highest current market prices, while leaving the other stuff in the ground for a rainy day.

The one-trick ponies (those without a poly metallic deposit) are in a tougher spot. But if you believe China’s stimulus package announcement marks the long-sought shift in the Chinese economy away from exports and towards domestic consumption, well then it’s not all bad news for the smaller Aussie resource juniors. More on that tomorrow.

Outside the Lucky Country, General Motors (GM) is telling anyone who will listen that if it doesn’t get a bailout before Christmas, it may not survive to see Barrack Obama inaugurated as the 44th President of the United States on January 20th. GM shares closed under $3 for the first time since 1946. At $2.92, it was a 65-year low for America’s big auto-maker.

Some of Australia’s new handout to automakers will probably make it back to GM and Ford’s Detroit coffers. But if the companies are going to survive in their current form, it will take a mighty Federal hand out to make it happen. And hey, everyone is getting one of those these days. So why not?

It is a remarkable thing that the icon of America’s industrial manufacturing might is on the verge of recognising its bankruptcy. In some ways, GM’s downfall reflects the conscious decision of American policy makers and CEOs to pursue financial services over manufacturing, to favour white collar work over blue collar work, selling stocks over making things.

It started with the passage of North American Free Trade Agreement by the Clinton Administration with the help of Republicans in Congress. Before we get into the details, though, let’s be clear about what happened. The U.S. pursued a “strong dollar” policy when Robert Rubin was Treasury Secretary from 1995 to 1999 under Bill Clinton. The U.S. opened its consumer market to the world and began shipping manufacturing jobs overseas. In exchange, the U.S. got two things.

First, American consumers got cheaper goods via dollar pegs from exporters who kept their own currencies relatively cheaper than the dollar and sold into wide open U.S. markets. You saw a great disinflation in manufactured and retail goods and, not coincidentally, epic growth in China’s industrial production. Earnings for American firms who outsourced labour also increased, and were passed onto shareholders via rising stock prices (and more generous P/E multiples based on the rosy new scenario of lower costs, cheaper capital, and higher sales).

This led to a huge explosion in the current account deficit, most notably the trade deficit. America was buying a lot more than it was selling. But while the current account deficit climbed higher as a percentage of GDP under Rubin, America began to rack up a huge surplus in the capital account. And perhaps that was Rubin’s idea all along.

Foreign dollar holders recycled their trade (and later petrol) profits back into U.S. stocks and bonds. This drove share prices up and long-term interest rates (to which mortgage rates are linked) down. Consumers levered up based on rising asset prices (can you smell a housing boom?). And for awhile, everyone appeared to be getting richer, with more stuff available at lower prices, and ever more credit available to borrow against rising houses and shares.

Further, Rubin’s preference for running a surplus in the capital account favoured the boys on Wall Street. IPOs flourished. Investment bankers thrived. Financial product innovation exploded like a thousand brilliant suns.

And in another fortunate side affect, Federal tax coffers swelled as capital gains taxes poured in from Wall Street. Corporate tax revenues poured in as well. When you threw in booming social security payments from the workforce along with the swelling tax take, the Clinton Administration was even able to give the impression that the Federal budget was briefly in surplus in the late 1990s.

But Rubin’s gambit has not paid off so well for the bulk of the American workforce, has it? It sent jobs overseas and by pushing real interest rates down, disincentivized saving. Savings rates accordingly plummeted while consumers took on more debt to make up the difference between their falling real incomes and their expensive (self-chosen) standard of living.

What hath Rubin really wrought?

By preferring to run a capital account surplus, Rubin essentially conceded that the current account deficit-a function of Americans consuming more than producing and spending more than saving-was an a priori fact of global economic life. He assumed the current account deficit as a fact, and engineered a strong dollar to boost the capital account surplus, which also just happened to be a huge boon to the financial services industry from which Rubin came from. He figured we’d become a nation of spenders and consumers, not savers and makers.

By the time a weaker dollar rolled around in the last year of the first Bush term, there weren’t nearly as many American manufacturers left operating that could take advantage of it. They’d all left for a siesta in Mexico or the world’s new workshop in China. America could compete on price, but there was nobody around to do the competing.

And now today we have GM, a car company that exists to pay off its accumulated healthcare and pension liabilities. It cannot make enough money by loaning money to honour the promises it’s made to its unionised work force. What would Rubin do?

Well, we know that generally in the Western world, government policy makers (many of whom come from the financial services industry or benefit from the contributions that industry makes to their campaigns) have favoured a pattern of trade that generates capital account surpluses and current account deficits. This is good for you if you’re in the financial services industry. Not so good if you make cars.

There is not much at this point that Kevin Rudd and Barrack Obama can do about it, assuming they would want to. And the bigger problem, at least for the U.S., is that foreign trading partners and central banks are no longer recycling trade profits back into American financial markets. Perhaps it’s because they believe the risk free rate of return from sovereign U.S. debt is no longer risk free.

And perhaps they’re right. The U.S. bailout plans take on debt via government borrowing in order to shore up the badly damaged and over-leveraged balance sheets of Americas financial companies. No real value is created. And what kind of investment is that? Besides, so far, the bailout has been a continuation of Washington to favour the financial services industry over real manufacturing.

In the next few days, and with Democrats in Congress pushing hard for it, the balance sheet bailout of the real economy will begin. And when it does, we think it will accelerate the movement out of U.S. Treasuries and into cash or even resources. More on how this happens tomorrow.

Source: What Do We Know Today?

Dan is referring to the Australia’s decision to postpone for 90 days the takeover of iron ore miner Murchinson Metals LTD (MMX) by Chinese firm Sinosteel.

Australia’s natural resources are attracting considerable attention from Asia’s emerging economies. But this has set off some political alarm bells about handing control over the country’s best assets to a foreign government.

But, says Dan, junior mining companies need access to foreign capital. Without it, they’ll won’t produce iron ore anyway…

Foreign Investment in Australia, How Much is Too Much

By Dan Denning

What is the Australian Federal government’s position on Chinese investment in Australian resources?

Yesterday the Foreign Investment and Trade Board told Sinosteel to cool its heels for 90 days while the government figures out how much of Australia it will sell to foreign investors. Sinosteel, which, as you might guess, is a Chinese steel company, already owns 43.6% of iron ore junior Mid West (ASX:MIS) and was given permission earlier this year to buy all of the company.

Sinosteel also owns about 2.4% of Murchison Metals (ASX:MMX). Sinosteel applied to buy Murchison as well. It wasn’t rejected. But as you can see from the official looking note below from the Treasury, published yesterday in something called the Government Gazette, the government basically told Sinosteel to go away for 90 days while it figures out what to do.

You can’t have the benefits of foreign capital without giving up some ownership. The whole development of the Mid West region WA will depend on foreign capital and joint venture partnerships. Sinosteel is active there because all the good ore in the Pilbara has been locked up by BHP (NYSE: BHP), Rio Tinto (NYSE: RTP), and Fortescue (ASX: FMG).

If the Mid West is to emerge as an ore producer at all, it will need Chinese investment. The government probably knows this. But it’s nervous about how things will look to the public. After all, Sinosteel is owned by the Chinese government. You would have the most promising non-Pilbara ore project in the country owned lock, stock, and barrel by a foreign government.

So what’ll it be Wayne Swan? Matthew Stevens reports in today’s Australian that the government may set a 49.9% ownership ceiling on how much a foreign entity can own of an Aussie share. While mathematically pleasing because it suggests a foreign investor would not own a majority of shares in any Aussie company, in practical terms it’s not a large limitation on how much influence foreign investors would have on the locally-listed firm.

The concern is that if state-backed Chinese firms take a controlling interest in Australian mining companies, those companies will no longer be run for the benefit of shareholders, but will be used to deliver raw materials at low prices to industrial consumers in China. Is that a valid concern? If China Inc. really runs like a vertically integrated manufacturer, it probably is a valid concern.

But perhaps the Rudd government should ask Australian companies what they think. In our investigations at our small cap letter, and in Al Robinson’s research at Diggers & Drillers, we’ve talked to plenty of small mining executives who have made access to foreign investment part of their business plan. Many small Aussie miners will not get their projects off the ground without importing capital and even labour from abroad.

The government hasn’t done anything stupid yet. But give it time. It seems to be an unofficial law in human affairs that people find a way to deliberately sabotage their own success. Governments, being large institutions, are especially good at this. The U.S. government, standing unchallenged militarily at the beginning of the millennium, found precisely the way to get involved in two costly wars and simultaneously drive up the price of energy from historic lows.

Maybe nature abhors a surplus. Until recently, most human beings went through their whole life with very little margin for error. Prior to the twentieth century, most people worked growing food and scratched out a living as best they could. It wasn’t until labour-saving devices and cheap energy allowed people to move off the farm and into the city that real abundance became possible for ordinary people.

Now, 150 years into the world’s energy revolution, all that abundance and surplus is being challenged by massive demand growth in the developing world. More people want more calories, more leisure, and climate control. Australia looks like it’s in the position to ride this boom until something derails it…or until the country finds a way to shoot itself in the foot. We wonder which will come first.

But wait! Have we gone all soft in the head here at the Old Hat Factory? A reader quotes Sir John Tempelton over at our website, “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” “You’re in there hard,” the reader says.

We have no idea what that means. But we think he means that we took a rather bullish tone in yesterday’s letter. He would be right about that.

There are still plenty of risks to the boom. Being too casual about them would be a mistake. Let’s say industrial production declines world wide as energy prices bite into globalisation. At some point, reduced industrial production leads to lower commodity prices and lower earnings for Aussie producers. Perhaps the revaluation of BHP and Rio from cyclical stocks to growth stocks gets undone if there’s a major global contraction.

We may also be overestimating the ability of Asian consumers to replace American consumers on the world stage. It’s clear it won’t be a seamless transition. But an increasing amount of Asian exports go within the Far East. Losing America as the big customer will hurt. But it will not be a deal breaker for the region’s development.

We are also trying to keep things exceedingly simple from an investment perspective. It was complexity and derivative value on financial instruments that undid so many people on Wall Street in the last ten years. By comparison, the resource industry is a breath of fresh air.

The value of projects is a function of costs and commodity prices. Companies can be held accountable for how well they execute strategies. Smart people don’t usually get involved in dumb mining projects. So following the smart people isn’t a bad start.

Are we overly euphoric? Nope. But there is a certain relief that comes when you have a clear investment strategy. Your strategy has to adapt to changing conditions. But the long-term conditions we see driving the resource boom (and the deflation of the global real estate bubble) are pretty favourable for Aussie investors.

Nothing is risk free. But Australia is on the right side of what we called “The Money Migration” a few years ago. It is the vast transfer of wealth, incomes, savings, capital, and standards of living from the West to the East. Maybe it’s overly simple as a metaphor. But for some reason-usually because it’s right in front of their face-people often miss the most obvious explanation for events.

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Source: Foreign Investment in Australia, How Much is Too Much

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

–That’s the percentage increase in the annual iron ore contract price Aussie producers charge major Chinese steel makers. It includes the much sought after “freight premium” which recognizes that its cheaper to ship ore from Australia to China than from Brazil to China.

–So what does it mean? Well, Chinese producer were hoping to NOT have pricing power in the ore industry lie with suppliers. But that hope seems to have faltered. Time for plan B. Plan B is to take equity stakes in a large number of smaller Aussie ore producers (see yesterday’s DR, and don’t discount the possibility of China Inc. taking a large stake in BHP a la Chinalco in Rio Tinto).

–Plan B also includes raising steel prices. Granted, as you can see from the chart below, courtesy of Macquarie Research, steel prices are already up 65% this year alone. But as you can also see, Chinese steel prices trade at about a US$400 discount to U.S. and world export steel prices. Whether this is how the Chinese subsidise domestic steel consumption or not, we can’t really say.

–But we can say that Chinese producers will increase exports this year and raise prices. Prices for domestic steel in China might differ from export prices. Who knows? But either way, you can be sure the Chinese steel producers aren’t simply going to absorb the huge increases in coking coal and iron ore. Chinese steel is going to get more expensive, whomever the buyer is.

–Normally, you’d expect to see higher commodity prices curtail demand. But for both steel and oil (see below) you haven’t seen any evidence yet that higher prices are slowing down demand. In fact, as this second chart from Macquarie shows, Chinese steel production is slated to grow by 10% this year. It even looks like the double bottom in steel production growth rates is in. Is it the beginning of a new steel boom?

–One company that hopes steel prices keep going up is Aquila Resources (ASX: AQA). The company told investors yesterday that it could produce about 25 million tonnes of iron ore per year from its ore bodies in the Pilbara…for the tidy sum of $4.1 billion.

–Welcome to the iron ore boom, Aquila (a company which also has coal and manganese assets). The company’s announcement was a little like a new doctor in a small town hanging out his shingle right across from the old doctor. The company isn’t producing anything yet. But like the other ore hopefuls in the Pilbara, it believes that with a little capital and a little deep water port facility at Cape Preston, its pre-feasibility study indicates it would have a nice little business.

–What is the difference between a shingle and a “for sale” sign?

–Meanwhile, the original third wheel in the Pilbara, Fortescue Metals (ASX:FMG), begins loading its ore for shipment to China this week. It’s been a long time coming. But FMG’s business has opened the door in the Pilbara and the Mid West for a long roster of other, smaller ore producers. The good old days of just BHP and Rio are long gone.

–What about oil? It just keeps going up. It reached nearly US$123 in New York trading over night. The Masters of the World at GoldmanSachs repeated their claim that a ’super spike’ in oil could drive it to US$200, on the back of red-hot demand in the developing world and the “non-recession” in the U.S. Supply bottlenecks won’t help.

–”China may be chasing Twiggy,” reports Matthew Stevens in today’s Australian. “There is talk in New York that the Rudd Government has approved an application from China’s Baosteel to acquire 16 per cent of the iron ore maverick, Fortescue Metals Group (ASX: FMG). Fortescue says it does not know whether its biggest Chinese customer has even made an application to the Foreign Investment Review Board, let alone received a green light.”

–Fortescue is the low-hanging fruit in the iron ore sector. It’s easy pickings. It aims to be the third major ore producer in the Pilbara, behind BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). It’s not surprising that Baosteel-China’s largest steel maker-would go over the biggest plum in the pie.

–What IS surprising is just how far into the iron ore sector Chinese companies are drilling for ownership of undefined resource bases that are years away from production. It speaks to the strength of demand for iron ore…and the itch in Chinese pockets to trade U.S. dollars for real assets before the dollar falls even more…or before the Chinese revalue their own currency.

–First up on the menu yesterday was FerrAus (ASX: FRS), a member of the North West Iron ore Alliance we mentioned last Thursday. China’s Shanghai-listed Western Mining Company announced its intention to take a 10% stake in FerrAus at $1.15 a share through a share placement arrangement. Regulators have to approve the deal.

–Here’s the interesting thing about this deal; Western Mining is a base metals miner. It doesn’t even produce iron ore. It just likes the cut of FerrAus’s jib. And for its part, Adelaide-based FerrAus hasn’t even proven up its indicated resource of 43 million tonnes. But hey, when the market value of the assets is going up, these kinds of deals get done.

–And there are more of them. Gindalbie Metals (ASX:GBG) shot down rumours that Angang and Iron and Steel was seeking to increase the 13% stake it already has in the mid-West iron ore junior (a member of the Geraldton Iron Ore Alliance). Investors may or may not have been convinced. But they seemed to like Gindablie’s announcement that it would spend $10 million this year on 12 drilling targets that it hopes will yield 80-100 million tonnes of hematite ore in the Pilbara. The shares closed up 16%.

–And the beat goes on. Prosperity Resources (ASX:PSP) announced that Shougang Holding Limited would buy up to 19.9% of the company through a share placement. To be honest, we had never even heard of Propserity Resources until this morning. Perhaps we are not digging and drilling thoroughly enough.

–We do like at least one thing about the company, though-its ticker symbol. PSP is the acronym we’ve taken to using for a new research service we hope to launch soon, the Penny Stock Prospector.

–We want to offer your our research into the junior mining and energy shares…and hopefully suss out the shares that are moving. It will be as close as you can get to pure speculation. But there’s so much going on in the resource sector now that it’s more than we can cover in Diggers and Drillers.

–Low-hanging fruit is easy to pick. But there’s plenty of fruit on the tree if you’re willing to shake the tree a little. If the PSP sounds like something you’d be interested or you have a hot share tip you can’t wait to share, drop us a line at dr@dailyreckoning.com.au

–By the way, the Koreans are getting busy too. Posco, the world’s fourth-largest steel maker, announced its intention to buy 19.9% of Sandfire Resources (ASX:SFR). The mineral grab goes on.

Source: www.bigcharts.com

–What do you think of the chart above? Seriously. Can you really believe spot crude oil is up 53% in the last year? Oil rocketed up in New York overnight, busting through US$120 before settling just below at US$119.67 by the time trading got going thismorning in Sydney.

Take bananas a few years ago. One day you could walk into a store and buy them cheap. A few cyclones in Queensland later, and banana prices were through the roof. For most share investors, this wasn’t an opportunity. It just made bananas and banana bread more expensive.

But in other markets – especially resource and energy markets – a sudden change in the availability of basic resources can change everything. A commodity can go from abundant to scarce relatively quickly. Its price can go from cheap to expensive quickly as well. Naturally, the share prices of companies that produce volatile commodities can change quickly too. We’re counting on that this month.

The Leading Edge of the Energy Storm

The high cost of energy – especially coal and oil – is directly impacting resource production in two countries: South Africa and China. As energy prices grind higher – or even hold where they are – this will force the production of certain base metals to lower-cost countries. It will also change the supply-demand dynamic for these base metals, creating new investment opportunities in the process. A good example is South Africa.

You have no doubt read about the power crisis in South Africa. South Africa has a booming resource economy like Australia’s. It’s driven by gold, palladium, platinum, coal, diamonds and other resources.

The trouble is, South Africa’s economy is growing faster than its electrical industry. Contrary to all the gloomy reports, we found the place pretty positive when we visited in late February (mostly Johannesburg). Like any fast growing country starting from widespread poverty, you’re going to have a lot of chaos, crime and uncertainty.

But one of the few things you want to be able to count on is the power. You flick a light switch, the lights go on. That’s so basic that you and I take it for granted. Not so in South Africa. The folks who run South Africa’s only large power company told the government years ago that it would have to invest more in power to keep up with the economy’s growth. The government didn’t listen.

The result is what you have today: rolling blackouts and “load shedding” by the power provider. Demand for power has grown much faster than the available supply. This is not make-believe land. When demand exceeds supply something has to give, and in South Africa, that means power must be cut to someone.

Energy-Intensive Industrial Users on the Chopping Block

The government’s first response to the power crisis was to cut supply to the places that used the most of it, namely the suburban business parks where most of Johannesburg’s business community has relocated in the last yen years. That makes sense. You can only cut power to people who are using it. But cutting power during the middle of the business day unexpectedly is not exactly good for business, or for people’s state of mind.

The government decided to look at industrial users of power. And once it did that, it wasn’t going to be long before South Africa realised – like China is now realising – that there is one particular industrial process that uses much more energy than any other: aluminium.

You make aluminium in several steps. First, you have to refine bauxite ore into alumina. Then, you turn alumina into aluminium by adding generous amounts of electricity in an established process. I won’t go into the details. But the basic ingredients are what we want to focus on: bauxite and energy.

Bauxite is plentiful. You can find it all over the world. Australia happens to have plenty of the stuff. But it is not alone.

Australia is the Saudi Arabia of Bauxite

But first, congratulations to Andrew Forrest! Ever since Lang Hancock and other pioneers opened up the Pilbara to the world in the 1950s, the region has been dominated by BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). Those two quarreling love birds have thus far owned all the rail and port infrastructure to export Australia’s red iron ore to China, Japan, and Korea.

The duopoly has become a triopoly as of this weekend. Fortescue Metals (ASX: FMG) completed the rail line between its Cloudbreak mine and its new port facilities on the coast. Fortescue still hasn’t actually shipped any iron ore yet. But the company can now get the iron ore from the mine to the sea. Its first shipment is scheduled for next month.

Don’t expect Fortescue to produce iron ore in the same volume as the big boys. But then, it doesn’t have to. The iron ore market has changed at the margin. Smaller steel makers in Asia are more than willing to enter into contract agreements with smaller ore producers in Australia.

This is a key feature (and opportunity) in the resource boom: the expansion of consumers has led to an expansion in producers. The marginal producers (some of them anyway) are now economically viable. The whole market is bigger, giving retail investors more to choose from in the share market.

Three billion people in the world eat rice as a staple of their daily diet. No wonder there are rice riots. Javier Blas of the Financial Times reports that, “Rice prices rose more than 10 per cent yesterday to a record high as African countries joined south-east Asian importers in the race to head off social unrest by securing supplies from the handful of exporters still selling the grain in the international market.”

Rice farmers are sitting on huge profits. It’s not complicated. There are more buyers than sellers. And the sellers are selling something pretty valuable: daily calories. This isn’t your garden variety shortage in video game consoles or iPhones.

“The rise in prices – 50 per cent in two weeks – threatens upheaval and has resulted in riots and soldiers overseeing supplies in some emerging countries… The increase also risks stoking further inflation in emerging countries, which have been suffering the impact of record oil prices and the rise in price of other agricultural commodities – including wheat, maize and vegetable oil – in the past year.”

“Bankruptcy filings jump 30%,” reports the Los Angeles times. “More than 90,000 bankruptcy filings were made in March, the highest since insolvency laws became more restrictive in October 2005,” the Times reports. “California led the nation with a 42% increase in bankruptcy filings at an annual pace in the first quarter, according to Jupiter ESources.”

California is always at the leading edge of American economic trends. This is not a good sign. The bankruptcy laws passed in 2005 were a big fat wet legislative kiss to the credit card companies. They make it very hard for Americans to declare bankruptcy. The fact that so many have anyway tells you how grim the situation is.