Could this have worked out any better for China? We’re talking about the position Rio Tinto put itself in by taking on US$38 billion in debt to acquire Alcan—and stave off the unwanted advance of an amorous BHP. Now, in a world where refinancing that debt is near impossible for one of the world’s largest miners, it must sue for peace with a strategic partner.
The total value of the deal is $30 billion. Chinalco gets a minority stake in some of Rio’s crown jewels, including the iron ore project in the Pilbara. It’s not cheap. Chinalco is paying a US$12.34 cover charge to get into the Pilbara, according to today’s Australian. But it’s oh so worth if it if you’re looking to source your steel industry’s long-term ore requirements.
You know for a fact that Rio’s directors did not wake up in July of 2007 and ask themselves, “How can we destroy shareholder value, imperil our jobs, and transfer ownership of our prized assets to our customers today?” Nobody entrepreneur waked up in the morning wanting to make the biggest mistake of his life.
Rio got caught in what Murray Rothbard called the “cluster of errors” that appears at the end of a credit boom. Normally, entrepreneurs make their mistakes discretely, in an uncorrelated fashion. One man correctly reads the emerging need for overnight transport of goods (FedEX) while another man opens a steakhouse in a neighbourhood full of vegans.
But in a credit boom, the abundance of money causes everyone to miscalculate at the same time. Entrepreneurs—who as Rothbard points out are in the business of forecasting future demand and meeting it with new supply—misread the market based on demand that has been falsely stimulated by the availability of cheap credit. When the credit goes, the businesses find they’ve expanded for a demand which was never really sustainable.
Of course it’s easy to say all that with the advantage of hindsight. If they knew then what they know now, Rio’s directors probably wouldn’t have saddled the company with $40 billion in debt on the eve of a credit depression. But then, we can never know then what we know now. As investors, all you can do is look for management team’s whose assumptions about the future are not “excessively forward looking.”
Rio will just be fine, one way or another. What’s really disturbing at the moment is how many economic mining projects are in danger of shutting down because finance is drying up altogether. And we’re not talking about greenfield mines or exploration projects. We’re talking about mines that are already mining ore or have completed all the necessary permitting.
Financing is now a critical problem. Hmm. Do you think there’ll be a government bailout for miners with economic projects who simply can’t refinance their loans? Probably not.
Over in New York, the Dow Jones did its best Lazarus imitation and rallied nearly 200 points in the last fifty minutes of trading. It still finished about seven points down on the day. But that’s better than 200 points down.
Is it over yet? No. Not yet. The Financial Times reports that, “Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.”
“The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.’
What about the other half? Uh oh…
Our old London desk mate Adrian Ash at Bullion Vault writes in…
Hey Dan loved your man’s story about the Kiwi gold dealer who went bust in the late ’80s. GoldCorp cost some 1,600 private buyers their entire “investment” after BNZ demanded (and was awarded) what little gold there was.
Like several other local titans blown up by the ’87 crash, Ray Smith the man behind Gold Corp even wrote a book about it in the mid-90s, trying to downplay his role in the scandal, entitled Where’s the Gold? Must’ve had balls of brass. Try blaming the private-investor losses on BNZ instead, I’m told. But the key point for gold investors came right at the top of your reader’s story, when he refused to accept Goldcorp’s certificate in lieu of gold.
Your reader said the secretary told him, “Oh no. Nobody does that nowadays [takes physical delivery]. It’s much too risky. We store all our customers’ gold in our vault. And it’s a free service”.
Everything you needed to know about Goldcorp’s business and risks was spelled out right there:
#1. Title was vested in that piece of paper “your proof of ownership” rather than in the gold. That’s the problem, legally speaking, with certification. The more persistent risk, physically, lies in over-issuance…selling more certificates than there’s gold in the vault [ed note sounds like fractional reserve banking]. Which is why, here at BullionVault, we publish a central register of all customer property instead. Anyone visiting the site can then prove it against the full list of all gold bars held by our vault operators.
#2. The gold “sold” to the buyer wasn’t necessarily in the vault anyway. That’s made clear by storage being “a free service”. Because just like several of the leading gold programs running today, storage can only be free to the buyer if the gold doesn’t actually belong to him or her. It’s what’s known as “un-allocated” making the buyer an unsecured creditor, in the same way that cash depositors are unsecured creditors of commercial banks.
The final judgment in the Goldcorp case realized this, over-turning a previous decision that said non-allocated gold could be subject to a proprietary claim by unsecured creditors. But it can’t, firstly because it won’t necessarily exist (!) and secondly because that free storage proves they don’t actually own anything.
Goldcorp was no more a custodian of physical property than your bank when it accepts a cash deposit. So whatever gold might have been in the vault could then be lent out or sold with or without the customer’s explicit knowledge because s/he was only an unsecured creditor, not an owner of physical property left in safe-keeping.
The moral? Always take DELIVERY if you want to get yourself off risk. Possession, on the other hand along with all the extra costs, hassles and lack of liquidity is another matter entirely.
And finally, this conversation from the pokey in the hotel we’ve been staying at this week on the Gold Coast. It was the end of a long week and your editor sat down to finish a glass of red wine over a bizarre looking game that had a giant red kangaroo on it. It was called “Big Red.”
“How can three eagles not win a hand,” we asked the stranger to our right, trying to figure the game out?
“I don’t know. What kind of eagles are they?”
“I don’t know. I think they’re brown eagles. There’s no gold on them.”
“Maybe it’s a sea eagle.”
“Maybe. But…shouldn’t three eagles win something.”
“Not necessarily. It looks to me like you’ve got eagles there. But you’ve also got crocodiles…boars…let’s see…I think that’s a dingo…some gum trees…a queen…and a king. So they have to fit together somehow, or else you don’t get anything.”
“It sounds like a synthetic CDO?”
“Nothing…really. Nothing. Never mind.” And off to bed we went.
From Dan Denning on the Gold Coast
for Markets and Money