Surveying the Carnage

• Some countries are relatively unaffected by the metals price retreat. The ones largely immune, or unconcerned, are Argentina, Venezuela and Paraguay
• Brazil will see its nickel possibilities largely thwarted and faces a tough battle of the wills with China over iron-ore pricing. Gold prices are good enough (and the currency slump in the real large enough) that this activity should be sustainable.
• Bolivia, Mexico and Peru are going to encounter social pressures because of the important role that mining has in job creation and the sustaining of isolated communities.
• Mexico could do with more currency relief to help out miners on their average dollar production costs.
• Ecuador’s slowness in approving legislation means that the train has not left without it but has rather been permanently cancelled
• Peru is going to face big decisions once the Chinese come a’hunting after distressed Canadian-owned assets. They had better get some quick lessons in how to say “no” in Mandarin.
• Colombia is actually fairly well off. Coal prices remain firm and the internal dynamic means improved margins in this business rather than worsening margins. Gold is still in its formative stage there and so little was going on that the economic effect of lesser activity will scarcely be noticed
• We remain bulls on metals prices. The liquidity splurge to solve the financial crisis is here to stay and has produced a tidal wave of money that is yet to hit shore. Precious metals in particular will be beneficiaries of this squandering of monetary resources without commensurate creation of assets to back the extra money supply.
• Base metals are subject to some brutal manipulation at the current time combined with a liquidity crunch. Basically once the non-trade players are removed (already achieved in our opinion) then the eternal supply/demand factors will come into play. Capacity is being closed down left and right with commensurate supply reduction. This lays the ground for price spikes and, further down the track, the derailing of so many projects means an even tighter supply situation two years out for almost all metals we could imagine.

End of Reflation or Just a Headfake?

The dramatic collapse in base metals prices can be one of two things. The first would be an end to the reflation that has reigned since 2002. The second would be a transitory reaction to the liquidity crisis with some semblance of normalcy restoring some but not all of the shine that the base metals have enjoyed in recent years. We are of the opinion that the last few years have not been “just an economic upcycle” in the commodities space but rather that the upcycle finally exposed the years of under-investment in the mining space which has resulted in a severe supply/demand imbalance. Metals are returning the age before 1973 when they had real value. They are no longer the poor relatives of the economic system. They are finite resources in a resource-limited world.

On the second point we would agree that the liquidity crunch produced massive distress that went to the core of even the most convinced commodity groupies. When push came to shove, the baby went out with the bathwater (if we can mix our metaphors). While some commentators have grasped onto the Baltic Dry Freight Index as an indicator of impending doom, one can’t do much better in base metals than looking at LME, however imperfect and manipulable those numbers are. The key factor to note here is that stocks have really not gone ballistic as in the past when there has been a slump in demand. While they have moved up, and by sizeable percentages off their lows we would note that zinc going from a stockpile of three and half days of global usage to 4 days of global usage, scarcely ranks as a deluge of supply. The stocks are minimal compared to the “bad old days”. Some metals, like zinc and nickel are trading at “bad old days’” levels without the stocks reflecting any commensurate “collapse” in demand.

Evo’s bark is much worse than his bite.

• The media and foreign interests have conveniently lumped Evo Morales in with the politics of Hugo Chavez. In a world where the Morales government has few kindred spirits it has coalesced with the Venezuelan leader out of convenience rather than conviction
• Bolivia is fabulously wealthy and prospective on the mining front, having been for hundreds of years the very paradigm of a mining nation with its fabulous Potosi mine. A new era of exploration and production has begun.
• A handful of miners, including some international majors are forging ahead in Bolivia with minimal hassle.
• The Half-Moon provinces have been agitating for independence. This may yet be achieved, however, we would note that this would make the “upper” half of Bolivia even more dependent upon large-scale mining for its financial survival. The resources or skillsets for “go-it-alone” in a nationalized context do not exist.
• The Morales government has an obsession with reversing the corrupt Comibol privatization, and rightly so, however its efforts are being painted in a negative light because Xstrata (XSRAF.PK) is the main party in the spotlight for having ended up with the wrong assets. This is more a reflection of Xstrata’s failures in due diligence than on the Morales’ government in our opinion.
• The Morales government is not the unsophisticated revolutionary regime that many would paint it. Peasants are renowned for their instinct at self-preservation and bettering their interests, foreign investors should interpret the reports and actions in this light.

The Weight of History

Excerpts from Hallgarten & Company's recent 'Metals Outlook' report by Christopher Ecclestone:

• • •

"In this way only was the power of the local authorities vindicated amongst the great body of strong-limbed foreigners who dug the earth, blasted the rocks, drove the engines for the “progressive and patriotic undertaking.” - Nostromo, Joseph Conrad

• The truism would seem to be that those countries with booming outsized revenues from energy are those that also imagine they have most latitude to say “no” to mining
• Countries like Mexico have “been there and done that” and realize that mining provides more jobs in a wide range across the country that oil and gas production does not. Moreover mining provides tax revenues when energy revenues start to go into decline. Mexico’s dinosaur Pemex should be a lesson to all those countries in LatAm that imagine they can “do without” mining.
• There is a lot of press focus on travails of miners in LatAm. However, the vast bulk of foreign and local miners are doing quite well and are finding professional and encouraging national administrations. The exceptions are obvious, with Venezuela being the leading offender. It has made itself a no-go zone and will see mining investment, and the skill-sets it brings, wither and fade away.
• One of the biggest problems at the moment is a rising tide of industrial disputes resulting in serious and extended stoppages at some of the major mines in Peru and Mexico. This is not a factor investors can avoid merely by focusing on political risk.
• Environmental issues are important and the days of dumping waste near the local peasantry are long gone. Offenders in this category will quickly find themselves blockaded by locals carrying pitchforks and encounter bad local publicity that they may never live down.
• Thus, the problems for miners in LatAm are relatively low-key and definitely “dealable”. A few parties have been caught by erratic political actions, but the vast bulk of miners are plowing on with benign government oversight. Investors should not confuse self-inflicted problems of some miners, which they choose to dress up as “interference”, as reasons for avoiding any potential mining zone in the region.

Some Thing Change - Some Things Do Not

For those venturing into the waters of Latin American there is one volume and one alone, that they should read up in advance. The book in question in Nostromo, the masterwork of Joseph Conrad, in which a cavalcade or the idealists and the venal parade their hopes, suspicions and demagoguery on the subject of “the silver of the mountain”, the output of a famed mine in the breakaway province of Costaguana. Conrad welds a narrative, from his fleeting visit to Venezuela, which takes elements of the tumultuous (recent) pasts of Colombia, Argentina, Uruguay, Chile, Peru, Venezuela, Paraguay and a yet to be born Panama and creates a fictional land in which control of the loot is struggled over by the PTBs, both local, regional and international.

Next Trend in LatAm Mining: Eat or Be Eaten

• Tough times for mining stocks have evolved in equity markets since last September. Some issuance recovered in February and the best companies can always raise money but movements in prices are erratic and stocks are punished heavily at even the faintest whisper of a financing need.
• The response to tighter financing and beaten down prices should be an M&A boom over the rest of 2008 and into next year.
• The permutations that transactions might take will be far more varied than mere “big buys little”. We note a long list of possible types of deals.
• Things will not be as easy going forward for the Chinese buyers with their “all or nothing” approach. The “Softly, softly” tack taken by the Koreans is much more palatable to base metal miners in a relatively strong financial position.
• The precious metals miners cannot depend on Asian interest. There is a need for combinations to match money with virtuous projects. Silver is more vulnerable than gold to a fallow period in investor sentiment.
• Investors should be buying (or avoiding) based upon all the conceivable vectors of potential corporate actions that could interact with their holdings.
• Corporates should tear themselves away from their core samples for a while to consider other actions available to them now that the ATM of perpetual private placings is starting to sputter and maybe “swallows” their card!

Companhio Vale do Rio Dolce (RIO)'s recent results leave much to be desired, and explained.

Serious questions need to be asked about how much of a mining “major” Companhia Vale do Rio Doce (Vale) (RIO) really is the wake of its failed bid for Xstrata (XSRAF.PK).

The company did all it possibly could to secure the Xstrata approval but in the process damaged its share price, threatened to blow out its debt, endangered its ratings and raised questions about its ability to manage a truly diversified mining giant.

I believe that God favors those who try to help others. When people want to buy, I try to help them out by selling. When people want to sell, I try to help them out by buying.

There is a key difference between these others and Northern Orion. NTO would say it is a producer due to its purchase of 12.5% of Bajo de la Alumbrera. We would only agree with qualifications. NTO bought into Bajo only a few years ago. Its big project at Agua Rica has seemingly become a victim of the company shopping itself around rather than sticking to its knitting. In our experience there are two types of exploration companies. There are those dedicated to finding and bringing to production a deposit and there are those that find (or acquire) a deposit and then dressed themselves up with a big red bow and plant a “For Sale” sign on their stock.

Over the years, NTO proved to be opportunistic in snaffling assets as majors came and went. It got the Agua Rica deposit when BHP was no longer interested and it accumulated its stake in the massive Bajo de la Alumbrera mine that has provided it with all its growth and all its cashflow over the years. Gradually its cash mountain has grown. Agua Rica has remained on the drawing boards. NTO is “the dog in the manger”. It seems to be paralyzed waiting for a trade buyer to snap it up.

Argentina has no shortage of retail property owners, they have just not found it attractive to take its portfolios to the market. The addition of more competition might take the glow off APSA, however, with the other main shopping center operators (Unicenter/Von Paul and the Falak group) both in private hands, APSA has the stockmarket all to itself in its specialty (at least for now).

Alto Palermo – the Jewel in IRSA’s crown

The implication is negative real growth. The growth numbers still look stunning but they are coming at a price. The January CPI came in at 1.1% and there is little sign of moderation so we can safely annualise this number and come up with inflation that will be nigh on 13% in the current year. Growth even at a brisk 7% isn't even vaguely keeping pace with this inflationary tendency. Not only isn't the trend being contained, there are simply no policies in place or being mooted to grapple with it. Browbeating supermarkets and service stations operators may have achieved something in these areas but it is purely artificial and doomed to fail. Meanwhile construction costs are romping at 20% per annum. Move over Manhattan!