THE DISTILLERY: Steel cuts

The big story yesterday was the announcement by the iron ore cartel of anticipated large price rises for ore contracts in the September quarter. This comes amidst a 30 per cent sell-off in other base metals – as Stephen Wyatt of The Australian Financial Review commented yesterday, "...copper tumbled to eight month lows ... aluminium fell to its lowest level in eight months, zinc to 11-month lows, and both nickel and tin to four month lows.” 

Given this divergence, and the importance of the bulk commodities to Australia, this strikes this column as a major oversight by commentators. If we are to believe the majors, why is iron ore holding its own? Scouring the internet, this column finds only peripheral international comment on the issue, too. In a report in the China Daily we find the following: "Chinese steel mills are facing a precarious situation in the third quarter due to falling product prices and rising raw material costs, forcing many of them to scale back output or opt for maintenance shutdowns, leading industry experts said on Monday. 'Some steel producers are already tottering on the brink of losses. They will have to make output cutbacks or resort to maintenance shutdowns, if the prices continue to fall,' said Zhang Lin, an analyst with the Beijing-based Lange Steel Information Research Center.” 

A comment posted at zerohedge.com, backed by a Reuters news report, confirms the fraying sentiment: "Today in Shanghai Baosteel Chairman made further cautious comments: 1. Weak demand – particularly auto and appliance (flat rolled) 2. Production cuts coming 3. Iron or benchmark prices to peak in Q3 (CLF is largest US name) 4. Challenging 2H for steelmakers.”

This column will also note that the bulk commodity index, the Baltic Dry, has reversed its recent spike and is exhibiting an accelerating plunge. If Australia is to be drawn into a global double dip, this is where we'll see it coming. The above evidence is thin and is no doubt coloured by propaganda, but that's the point. It screams out for authoritative comment.

Matthew Stevens of The Australian is at least in the right territory in covering comments in Japan by the Trade Minister, Simon Crean, on the Pilbara JV. According to Stevens: "Crean said Japanese concerns about the JV were aired in all but one meeting he had with officialdom and business through his visit. After observing, rather oddly, that the RSPT was just an 'information-sharing' exercise, Crean went on to declare that Japan's concerns about the Pilbara production merger were 'real', they were being echoed in Korea and China, and the fathers of the proposed merger, Rio Tinto and BHP Billiton, had so far failed to make their case to the regulators. He then suggested the companies would do better to spend more time marketing their JV and less complaining about a RSPT that he claims is of little concern to our trading partners. Crean's commentary has, not surprisingly, been received by the Pilbara's new best friends as a less than subtle warning that continued government support for their deal might be helped by toning down the vigorous and effective public campaign against Kevin Rudd's resource super-profits tax.”

This column agrees with Stevens that these two issues are separate and should stay that way. However, it can't see anything wrong with Crean's sympathy for our Asian customers. They have been on the receiving end of monopoly-pricing endeavours by the iron ore majors since at least 2007. The Pilbara JV is absolutely no different, with today's greater emphasis on short-term contracts making control of supply a more important price-setter than competing marketing arms. 

Still on mining, and a couple of political analyses from Liberal Party experts make interesting reading. (This is what business commentary has come to – political commentary). First, Peter Van Onselen of The Australian joins the growing ranks of commentators recommending a government compromise that brings the resource super profits tax (RSPT) into line with the Petroleum Resource Rent Tax (PRRT). Van Onselen argues that by doing so "...Kevin Rudd and the Labor Party would be able to paint Tony Abbott and the Liberals into a corner as not equipped to deal with the two-speed economy and not friendly towards business ... For all the problems with the new resource super profits tax – its design, the selling of it, and the way it was thrust on industry without adequate consultation – if it is reworked to resemble the petroleum resource rent tax, it would be hard for the mining sector to maintain the support of a majority of the public ... By opposing the RSPT and the revenue it will generate for the budget, Abbott also opposes Labor's cut to the company tax rate from 30 to 28 per cent (the two initiatives are tied together). In fact, the Coalition plans to hit many businesses with a 1.7 per cent hike in the old company tax rate to fund its paid maternity leave scheme ... That means there will be a taxation difference of nearly 4 per cent between what Labor is offering businesses outside of the mining sector and what the Coalition is offering. It is at this point the dangers of the two-speed economy and how to address them become important ... By taxing the miners more and reducing company taxes across the board, businesses engaged in less lucrative parts of the economy are better able to compete with overseas industries.”

This looks like solid reasoning to this column but should also be contrasted with the advice of Peter Costello writing in The Age who suggests "...the government will begin the backdown by increasing the rate of interest on carried-forward expenses – probably to the rate applicable to the petroleum resource rent tax. It will not be enough. At the very least, the industry wants the new tax to apply only to new projects. It should avoid any hasty compromise. It has withstood a misleading campaign and turned it around. It will never be in a stronger position than it is now.”

This column is not a political commentator, but can see a couple of points. First, it will note that it is not the miners that are up for election. By any standards the current opposition is weak, as evidenced by polls showing much of the bleeding in government support has been toward minor parties. So long as the RSPT debacle continues, Abbott has the chance to run a 'small target' campaign and remain unscrutinised. Shifting the focus back to the opposition will not enhance their electability. Second, Rudd's ridiculous attempt to shift from staid Presbyterian reformer to class-warrior and tough guy is completely on the nose with voters (admittedly this column thought it might have served him better). His attacks on prominent miners are only serving to debase the office of the Prime Minister. A renewed demeanour of compromise is closer to the cautious Christian demeanour voters bought at the last election (notwithstanding that he is badly damaged goods). Third, if the compromise is forthcoming, it will leave the mining campaign with a stark choice – persist in an all-out bet on the opposition and risk facing a Greens controlled senate or come to the negotiating table. Finally, the great unknown for all is the economy. If iron ore prices soften before the election, as this column expects, the dollar will fall further, and the 'battling the two-speed economy' line championed by Van Onselen will be a much tougher sell. Perhaps the iron ore majors should go soft on China for a quarter or two. 

Speaking of which, Malcolm Maiden of The Age looks at equity market valuations and sees risk being discounted: "Another way of looking at it is to say that price earnings multiples of 11.3 times expected earnings in the next year in Australia and 11.9 times expected earnings in the next year for the S&P 500 galaxy of companies in the US have only been beaten for ''value'' once in the past decade: in the last quarter of 2008 and the first quarter of 2009. However, the question remains whether risk premiums are high enough to embrace potential outcomes of the northern hemisphere's debt overdose, the descent of the euro and Beijing's attempt to suppress reckless economic activity, to name just three prominent unknowns.” Maiden concludes "... there will be a way through the northern hemisphere's myriad debt issues, but it is not obvious yet.” In short, this column will add, valuations are a trap right now.

Also on big picture developments, Tony Boyd has an interesting comment on one of the great untold stories of Australia business: the success of the Commonwealth Bank in Asia. In one of this column's former roles, at The Diplomat magazine, it noted that CBA overtook ANZ's Asian earnings in 2007 and has been extending its lead ever since. Boyd quotes Baillieu analyst, Stewart Oldfield, who points out that CBA's higher multiple and the currency "gives it the ability to make deals that are earnings per share accretive.” This column will note that it would be quite a show if two Australian banks went head-to-head in the region over an acquisition – Boyd highlights Standard Chartered as one possibility. Of course, CBA's expansion would hit a brick wall if Australian housing came a-cropper.

Still on Asian connections, John Durie of The Australian looks at Qantas' move away from freight, as well as offering an interesting insight into Woolworths' hardware push: "The new stores, reported to go under the 'Master' brand, will be 60 per cent Bunnings-type products, 20 per cent Goods Guys and 20 per cent Ikea.” This column can see the benefits of pursuing a 'blue ocean' strategy for Woolworths in mixing hardware with other home-building products (rather than simply replicating Bunnings stores) and its buying power no doubt means it will not miss out on the wholesale savings available to the category killer. Nonetheless, it wonders at the wisdom of mixing retail genres when mixed business department stores are in chronic decline.