Chinese Worried about BHP Billiton/Rio Tinto Deal

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Includes: BHP, MTL, RIO
by: TraderMark

I keep saying these Chinese communists are some of the best darn capitalists I have ever seen....

Interesting article from Forbes detailing some of the behind the scenes moves China is doing to try to block this potential mega merger in the mining industry between BHP Billiton (NYSE:BHP) and Rio Tinto (RTP). The article states there is also some connection with the dry bulk shippers, but I am not buying that angle. I did write on this last week [Rio Tinto Up... $108!] and this kind of merger should raise some serious questions concerning concentration of power in such few companies.

This should have serious world regulatory issues as combining the #1 and #3 mining companies in the world should cause some concerns - together they would control 1/3rd of the world's iron ore according to CBSMarketwatch.

Now if this move only affected two US companies, I could see it flying with no problem (only superficial jawboning before giving in) - here we celebrate such concentration (anti trust? hahah) but since those pesky Europeans seem to like competition more than our domestic regulation bodies (wait, I thought we were the pure capitalists? Aha, corporations pay for politicians influence, hence when they try to supress free markets as much as possible its ok - got it!)
  • In addition to roiling the mining industry, BHP Billiton's aggressive move to buy rival Rio Tinto has left the dry bulk shippers on the rocks as investors wait to see how China will react. China is the largest customer of the two mining giants and a buyer of 50% of the world’s iron ore production. It appears keenly worried at the prospect of the greater power that BHP and Rio combined could wield over iron ore pricing.
  • “Instead of three miners controlling 75% of the market you’ll have a duopoly controlling the market,” said Oppenheimer analyst Tim J. Tiberio.
  • The state-owned China Development Bank was reported on Monday by Britain’s Daily Telegraph to have started building up a stake in Rio Tinto (RTP ) aimed at blocking any deal. China Development Bank issued a denial of the story. [Look at those capitalists go!]
  • A worst-case scenario is that China could downplay iron ore demand and hold off on purchasing, causing mining and shipping stocks to fall.
  • Another scenario is that if the deal goes through, China will accelerate consolidation of its state-controlled steel and coal mining industries, which it has been talking about doing for the last two years. Consolidation could create distortions in the supply chain which could impact dry bulk shipping in the near term, Tiberio said. However, in the long term, dry bulk shipping fundamentals remain strong, he said.
  • The last 12 months have seen enormous gains in the shipping industry as steel production and demand for raw materials in China have soared, allowing shippers to raise their rates. In the dry bulk shipping industry, seen even the worst stocks have skyrocketed as much as 150% in the last year.
  • But Chinese steel officials and importers have made their displeasure with high shipping prices known ahead of upcoming negotiations for iron ore prices for 2008; the Chinese Iron Ore and Steel Association has said that smaller steel mills could not afford any price increases.
  • Commodity analysts predict that China will have to endure between a 25% to 50% price increase on iron ore. Analysts have said that China has tried to hold off or slow down on chartering ships in order to “spook” the shipping industry.
  • But Chip Hanlon, president of Delta Global Advisors, said Monday’s pullback was to be expected given how much shipping stocks have risen over the last year. He called the fundamentals on the shippers “unbelievable.” “Every time the market worries about a recession and the market pulls back these stocks pull back,” Hanlon said. “If we do roll over into a recession the stocks will get roughed up. If not, it’s another buying opportunity.

I agree with Mr. Hanlon, and more than any true pricing decreases for the dry bulk shippers - the risk is more in sentiment. You have seen the past week what it looks like when investors flee en masse out of a burning building. So that makes even investing in the global growth story 'tricky', because the coming US recession (err slowdown), will impact the world.

Global growth will slow. But until new ships come online in 2-4 years, pricing will still be high. But as each month/quarter passes, investing in a sector like this carries more risk - unlike the areas I have over weight which I believe are far more insulated come heck or high water on the global economy.

With that said I am sure once the market gains its feet you will see another ridiculous move up as lemmings clamor for risk in this type of sector. Just keep in mind, every story has a time line and I'd argue dry bulk shippers is a shorter time line than many other secular moves. The problem is investors won't care about such fundamentals even if ship prices stay relatively high (even a tiny dip a few weeks ago saw these stocks lose 20-30% overnight) and as the past few weeks have shown the stocks will suffer, and suffer badly.

These 'perceptions' would also hurt mining stocks. In times of panic, fundamentals don't matter. Sentiment can change in a hurry and everything is thrown out. We saw this in the areas I find most protected from any slowdown - agriculture and infrastructure. The comment I highlighted in gold above also points to why I like Mechel (NYSE:MTL) despite a huge run in the stock. Coal, and iron ore - and a friend of China... all in one stock. With long term contracts I continue to favor iron over the other base metals which will get hit by a slowing global growth story first.

Long Mechel in fund; no personal position

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