LORD COPPER: Is Xstrata pushing its luck?

Annual financial statements from some of the major mining companies have not made particularly cheerful reading over recent weeks.

Not unexpectedly, they reflect the weakness of the global economy and emphasise just how vital growth is, for this sector as for most others.

Taking the rational view that such disappointing figures are a reflection of weak demand, some commentators and Xstrata shareholders are suggesting this indicates that a sweetening of the deal by Glencore is necessary to ensure fair treatment for Xstrata.

The logic appears to be that despite falling profits, the long-term value of Xstrata’s deposits should not be downgraded against current demand, but rather should be seen as a store of value, able to be liberated in the future (presumably in better economic times at higher prices).

That makes a certain amount of sense: the copper, iron ore and other reserves are not going to go away and we expect that at some point, growth and thus demand will return, boosting the revenues of extractive companies again.

The other part of the argument that Glencore should pay more suggests – by and large correctly – that Xstrata’s deposits are of higher quality than Glencore’s, and anyway, who knows what the future revenues of a flaky trading company might be?

It’s a reasonable point, but there is also a contrary view, which could be just as convincing.

Miners versus traders
Mining companies perform best in rising markets. That’s pretty obvious, because mining companies are by definition long of their products. The higher the price, the better the performance.

Even if they hedge forward production, they can still only partially offset the effects of falling prices, and they have very little chance of protecting themselves against excess volatility.

Contrast that with a trading company: prices can rise and prices can fall, but in both cases there is the chance to trade profitably.

The ability to be long or short, the chances created by market volatility, this is where the sleight-of-hand of the trader comes to the fore. Right now, we seem to be more likely to experience weakness than strength in the markets, so in fact the conditions look more beneficial for a trader than a mining house.

Future valuation is all very well, but the deal is happening (or not happening) now, so current circumstances must surely be crucial.

In the light of that, rather than Glencore getting valuable assets cheap, it looks more like Xstrata shareholders being offered a lifeline to help them through the rough patch.

And if you’re being given a lifeline, does it make sense to ask for more?

Lord Copper
editorial@metalbulletin.com

Keep up with the latest news on the Glencore-Xstrata merger here.