Reshaping the resources world

PORTFOLIO POINT: Glencore’s Ivan Glasenberg has big plans in the resources sector, and his top commodity picks are zinc, copper and coal.

It is unwise to ignore investment tips from a man who has made $7 billion in little more than a decade from playing the commodity market, but that’s what appears to be happening with the advice dispensed by Glencore chief executive, Ivan Glasenberg.

For at least the past 18 months the South African-born, Swiss resident, Australian citizen, has been telling the world that zinc is a metal poised to deliver fat profits because of a looming supply shortfall.

Now, in an exclusive (but officially off-the-record) conversation with Eureka Report in his London office, Glasenberg goes one step further and even puts a date on when the zinc price will perform as he has been promising.

“When Century shuts,” is his three-word answer to a question about when will the zinc price obey his command, and while it’s bending the rules of engagement preceding the half-hour conversation to use a direct quote, he probably won’t mind because the real reason for imposing a “cone-of-silence” rule is to ensure no secrets escape during the hotly-disputed plan to merge Glencore with its 34%-owned subsidiary, Xstrata.

Institutional investor anger at the terms of the Glencore/Xstrata deal are likely to delay the tie-up between the two companies, and possibly kill it completely. But, because it involves companies which have few Australian shareholders there is limited interest in explaining why Glasenberg’s grand plan has suffered a setback.

What is worth noting is the timing of the deal, Glasenberg’s commodity preferences, the nature of the business he is working to create, and the potential for a merged Glencore/Xstrata to change the structure of the entire resources sector – if it performs as promised.

The commodities set to run

First, his commodity preferences, a list topped by zinc, a metal he says is poised to rise sharply in price when the world’s second-biggest zinc mine, Century, in central Queensland, runs out of ore in roughly three years’ time.

The official closure date is mid-2015, with the mine’s current owner, China Minmetals Resources, admitting that it has failed to find enough ore to keep the pit operating beyond that date.

Producing at a rate of close to 500,000 tonnes of zinc metal a year, Century is topped on the zinc-league table only by the Red Dog mine in Alaska, with its annual output roughly equivalent to the annual global zinc production surplus said to be running at around 400,000 tonnes a year.

It is that surplus, a result of sluggish demand from the steel-galvanising business (the dominant use for zinc), and over-production, which has driven the price of the metal down from around $US1.60 a pound five years ago to its latest price of US86c/lb.

While others have been quitting the zinc market, Glasenberg has been loading up, a point highlighted several times on Eureka Report, including: The unloved metal comes around, and Zinc, for the big or the brave.

Those two earlier reports highlighted the big bets being placed on zinc by Glencore, bets that are yet to pay off, except through the fees peeled off by the commodity trading arm of the business Glasenberg runs.

The mines in which Glencore has a direct interest will have suffered, along with everyone else, from the low physical price for the metal. Those mining interests include a direct stake in Kazzinc, a big Kazakhstan-based zinc miner, the new Perkoa mine in the African country of Burkina Faso, and indirect zinc assets held by Glencore’s close associate, Xstrata.

Zinc has been such a poor performer over the past few years that it comes as a surprise when Glasenberg is quick to nominate it as the metal he has at the top of his future performance list, a view which is cold comfort to Australian investors who have been waiting for local zinc stocks to react to forecast supply shortfalls.

Local zinc miners such as Perilya, Bass, Kagara and Terramin, have been among the worst performers on the ASX over the past year, with Kagara folding into administration and Bass forced into a major corporate restructure because of low metal prices.

However, as Century starts to run down, and its supply of metal is only partially replaced by new mines, such as Dugald River’s 200,000 tonnes a year, the stockpile of surplus zinc will start to shrink, delivering a corresponding (but opposite) effect on the price.

Because he can invest with the firepower and balance sheet strength of Glencore (and Xstrata), Glasenberg is prepared to take an early seat at the zinc revival table. Lesser investors are best advised to watch, wait, and be prepared to move when Century’s closure date gets closer.

Copper is the second cab off Glasenberg’s preferred metals list thanks almost entirely to Chinese demand for the king of base metals and limited new mine developments. Nickel is far less attractive because of over-supply, and iron ore is heading into a phase of gross over-supply, when only the lowest-cost producers will profit, or so he says.

Coal, a commodity everyone loves to hate in a world fascinated by the climate change debate, is also on Glasenberg’s list of preferred commodities despite a falling price caused by rising US exports.

His view is that excess US coal production will not last long, nor do lasting damage, because there is limited port capacity in the US to raise shipments much further, and because much of the coal being exported now is effectively being “dumped” onto the global market because of a lack of local buyers.

As the coal market settles, and unprofitable miners are forced out of the market, prices and demand will recover, Glasenberg argues.

While hearing the zinc tip, and positive views about other commodities, from Glasenberg is encouraging there is another equally positive factor to be gleaned from a conversation with a man who knows how to play the commodity market on both sides of a transaction, either as a buyer or a seller – and always a trader.

Debunking the China syndrome

Like zinc, this is where Glasenberg’s contrary view is worth noting because he is certainly not a commodity bear, nor is he concerned about future Chinese demand for raw materials.

At risk of bending the no-quote rule again, here’s a second direct comment from the man himself: “China has not hit a speed bump, it has merely tapped the brakes.”

That view, which ignores countless negative reports about the outlook for the Chinese economy, is being expressed in more than words. It is on display on the proposed merger with Xstrata, which is being undertaken at a time when many investors are backing away from the commodity market because of concern that the China-growth story has run its course.

Glasenberg’s view is to totally reject any concern about China, a country he sees as a long-term consumer of imported raw materials, especially metals and energy today, and of vast amounts of food tomorrow, which is when the trading of Glencore kicks in with its deep exposure to sugar, soy and wheat.

Nowhere in Glencore’s central London office near Berkeley Square is there the slightest hint of concern about underlying commodity demand; even the weak price environment is partly blamed on the forced exit from the commodity-trading business by US banks under the controversial Dodd Frank Act, which applies strict new rules on US financial organisations.

A month before Glasenberg agreed to speak with Eureka Report he was expressing public optimism about China in a comment on the sidelines of Glencore’s annual meeting in Switzerland.

According to comments reported by the Financial Times newspaper, Glasenberg said he “had not seen a slowdown in Chinese demand”, blaming outside financial markets for the recent drop in prices (Dodd Frank).

“Overall Chinese demand continues to be healthy,” he said. “The global inventories of commodities is generally low, both on exchanges and within supply chains, a sign of physical tightness in markets.”

If those were merely the comments of a commodity trader seeking to talk up a market they could be dismissed as propaganda.

Xstrata today, Rio tomorrow?

But, that charge cannot be levelled at Glasenberg because he is acting on his own advice by seeking to merge with Xstrata at a time when more nervous investors are sellers of commodity-linked assets. In other words, he wants to grow when others want to shrink.

In effect, Glasenberg is repeating history because in 2003 he was a driving force in Xstrata’s brilliantly-timed acquisition of MIM Holdings (the former Mt Isa Mines), following up the 2002 purchase of an extensive portfolio of coal interests.

The MIM and coal deals, plus the 2005-06 acquisition of Canada’s Falconbridge, were done at a time when the rest of the world doubted the strength, or sustainability, of the resources boom.

A return of those doubts has dominated the resources sector for the past two years thanks to Europe’s financial crisis and China’s reversion to single-digit growth.

Glasenberg, however, is convinced that the current bout of depressed commodity prices is a buying opportunity, which is why he is trying to pull off the merger with Xstrata, a deal which will create a business to rival the world’s biggest miners, BHP Billiton and Rio Tinto.

Far-fetched as it might seem, a brief session with Glasenberg reinforces a suspicion that the $US58 billion merger with Xstrata is neither his last, nor his biggest deal.

Once he brings the commodity-trading Glencore and the mining-focussed Xstrata under the one umbrella he will have a business able to acquire even his biggest rivals.

Now, should he start with a raid on Rio Tinto, to give him the iron ore division he lacks?

Or, pick up where a fellow South African-born (Australian citizen) left off some 25 years ago when the late Robert Holmes a Court was forced to walk away from his ambitious attempts to snatch control of BHP in the days before it merged with Billiton.

Whether it is Rio Tinto, BHP Billiton, or the easiest target of all, Anglo American, there is no doubt the 55 year-old Glasenberg has bigger plans on his desk that a simple merger with a business in which he already holds a 34% stake.

Today, Xstrata. Tomorrow, the world!