more articles by

Jon Nadler

Click to enlarge Click to enlarge


Will You Marry Me? Ummm..Do I Have a Choice?

By Jon Nadler       Printer Friendly Version Bookmark and Share
Jun 22 2009 4:33PM

Good Afternoon,

Bullion values eroded swiftly as the market as the new week of trading commenced on Monday morning. Precipitated by a sharp decline in crude oil and a notable rise in the US dollar, gold fell back to near the $920 level with relative ease, despite the fluid situation that has blossomed in Iran over the past couple of days. The World Bank issued statements alluding to the duration and depth of the global recession, and it had nothing very optimistic to note about the same. Today's bright spot comes from Germany, where business confidence appears to show continuing signs of being positive in the face of current daily headlines.

In fact, the World Bank predicts a more intense as well as more prolonged contraction than previously expected. The institution now paints a picture of global contraction that could come in at a 2.9% rate this year, and it comes on the heels of previous forecasts of an 'only' 1.7% rate of shrinkage. It is, as numbers go anyway, far from growth of any kind. As a result of such prognostications as well as due to the Iranian internal issues, the dollar recaptured more than a modicum of safe-haven flows (as did the yen) and we thus saw corresponding declines in gold as well as black gold. The latter appears to have broken is 54 day-long run-up; one based more on spec funds at play than anything tangible (as the WB confirms) out there in the global demand picture at this time.

The New York trading day continued the selling pattern that started this morning, well into the afternoon hours showing a $12.50 loss for the yellow metal. It was quoted at $921.50 per ounce in early going, and was seen heeding the 0.50 rise in the dollar index (currently at 80.83) and the $2.62 slump in crude oil (now trading at $67.06 after last week's lofty $72+ bid). Participants continue to look for support levels near $915 to possibly undergo a test in the near-term. Absent that support plank and related possible bargain hunting, the market might walk off into the sub $900 value zone before this dip is over. At any rate, for the time being, the Bloomberg price survey taken late last week appears to have been validated by market action.

The $935 area was previously thought to be able to offer the floor that gold has been seeking since it backed away from the $1K level at the beginning of the month for a third time now. Scattered trader talk of a triple top has made its way into informal reports circulating in the trade, but it is still drowned out by incessant perma-bull calls (make that demands) for a moonshot trajectory that should take the metal to $1200 based on little more than the views of that camp. The battle of the words continues.

Silver fell 48 cents in late trading, and was quoted at $13.71 per ounce - likely the result of having paid attention to the WB recessionary alarm bell this morning, Platinum dropped a whopping $44 to $1161 and palladium lost $13 at $232.00 per ounce, likely on the same news. Bad news in the transport sector is not limited to automakers these days.

British Airways' fate hangs in the balance as of this writing, and at least one diagnosis - that offered by Sir Richard Branson - is that the airline should not/may not survive the economic slump. This, at a time when his own airline just booked an order for 10 Airbus A330 winged aluminium sausages. The great dinosaur die-off continues to unfold in various global industries as the worldwide slump nears its second full year of pain and chaos. The subprime asteroid was a lot larger than it appeared on anyone's telescopes initially.

While various reassessment are being made as to what was, how it came about, and as to the real size of the on-going problem, the analyses of why markets are behaving  so unpredictably pretty much all point their collective finger at the Fed. Everyone's favorite scapegoat appears to be lacking the clarity that markets so often demand before taking on a definitive trend and giving investors the 'all-clear' signal. Nothing is in fact very clear these days, and the Fed has its job cut out for it as it navigates through the summer months ahead.

This week's FOMC policy statement could go a long way towards giving markets a degree of the aforementioned clarity they seek. Much of the markets' recent fits and starts have in fact been due to the unwelcome spike in mortgage rates and the implications of a choking off of the 'green shoots' by rising rates. Even though rates have to rise, and will eventually rise.

Mortgage News Daily reports that: "The FOMC Policy Announcement could be the biggest release of the week if the Fed decides to shift policy, release updated forecasts, or hint at future tightening. The key interest rate is widely expected to remain in the zero to 0.25% band, so attention will be placed on the central bank’s purchasing of longer-term bonds and mortgage-backed securities.

And now, over to the mining sector for a quick dissection of some important merger news. Consolidation has been the name of the game in this niche for some time now. Of course, most investors are familiar less with the reasons for same, than with the staggering (80% and more) losses that some of the shares of many a firm has recorded at a time when the pundits had promised stratospheric returns from such investments. Most marriages are not only not made in heaven, in the case of the metals business they are certainly more of a business arrangement than some kind of romance coming to consummation.  Business Week takes the magnifying glass to the Anglo-Xstrata marriage and comes up with the following insights:

"This year is shaping up as the toughest in recent memory for the global mining industry. The recession has sapped demand from India and China for resources such as copper and iron ore, the core ingredient of steel. That has pulled down commodity prices from their 2008 highs—not to mention whacking revenues, profits, and valuations in the mining sector. At the same time, many mining companies, especially Anglo-Australian giant Rio Tinto, are saddled with huge debts after a decade-long merger-and-acquisition binge. The toxic combination of shrinking sales and towering debt has led to major belt-tightening across the sector.

Now comes news that two midsize miners may combine forces—further proof of the scramble to cut costs. On June 21, Swiss mining firm Xstrata confirmed it is holding merger talks with South African rival Anglo American. The deal would create a mining behemoth valued at around $65 billion, with market-leading positions in everything from copper to platinum, which is used in catalytic converters, among other things. The combined company would be among the largest in the industry, directly competing with heavy hitters such as Brazil's Vale and Anglo-Australian giant BHP Billiton.

"Consolidation in the mining sector will be one way for these businesses to remain competitive," says Chris Halliday, head of mining and natural resources at British law firm Eversheds. "The ability to make cost savings will be key to their success."

Aside from eliminating redundancy, another rationale to bulk up now is that commodity prices are starting to climb again. Since the start of the year aluminum is up nearly 10%, nickel and zinc prices have jumped roughly 35%, and copper has leapt a staggering 70%. Analysts credit the rebound to the effect of economic stimulus packages, especially in China, that have sparked renewed demand for raw materials. Buyers also are returning to the table after working down inventories that built up during the boom. A merger could leave Xstrata and Anglo American better positioned to take advantage of the upswing.

To be sure, the deal is far from done. Both companies say that discussions are still preliminary, and the South African government—a major shareholder in Anglo, which has most of its operations there—also wants to weigh in, according to news agency Bloomberg. Officials fear the proposed tie-up could lead to job losses in South Africa. As for Xstrata, Chief Executive Michael "Mick" Davis will need approval from the company's largest shareholder, Swiss metals trader Glencore, before any deal is done. Media reports suggest Glencore would back the merger. The deal may be done entirely in shares or a combination of shares and cash.

There are also unanswered management questions. It's not clear whether Anglo's U.S.-born chief executive, Cynthia Carroll, would be willing to take a backseat to Xstrata's Davis. And it could prove difficult to blend the companies' different business cultures: Anglo has grown organically over many years, whereas Xstrata has bulked up fairly recently through acquisitions.

Still, analysts say the combination makes sense. According to Citigroup, a combined Xstrata-Anglo would control 20% of the world's zinc market, 40% of the platinum market, and between 15% and 18% of the coal market. The deal also would give Xstrata a toehold in the lucrative iron ore business, which has recorded triple-digit price rises in recent years on the back of booming steel production in emerging economies. "A combination makes strategic and financial sense," says Citigroup analyst Liam Fitzpatrick.

The deal also could free up capital as the companies combine similar businesses, particularly their copper and coal divisions. Analysts figure the merged company could save $700 million to $850 million annually from synergies. Those funds could be plowed instead into new mines and other capital expenditures to take advantage of rising commodity prices. The opportunity to reinvest would be a boon to both companies, which had to cut their capex plans in the past six months due to the 2008 decline in commodity prices.

Then there's the competitive environment. Midsize firms in the mining business were relieved when a massive proposed merger between BHP Billiton and Rio Tinto was scuttled last year. But now the industry's two largest firms have struck a smaller though no less strategic alliance, agreeing to combine their iron ore assets in western Australia in a joint venture. That raises the stakes for the rest of the industry to achieve similar economies of scale and pricing power.

The Xstrata-Anglo deal isn't a sure thing, but analysts say the benefits of joining forces are clear. With emerging countries showing signs of economic recovery, miners have to ready themselves for the next commodities boom."

...Whenever that boom will finally come about, that is.

Until tomorrow,

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.