It’s All About Getting the Right Message

Remember my lamenting from a couple of months ago about the hollowing out of Canada’s big corporate names? Remember Falconbridge? Well, one of the foreign predators that snatched Falconbridge from right under our noses, Xstrata PLC, is now contemplating becoming prey. Why? Well, isn’t that a question now worth pondering…

Back in 2001, nearly everything about Xstrata PLC was second- rate: its properties, its diversification, its risk and capital management, you name it. Then the helm of the company was taken over by Mick Davis, who soon proved to be a miracle- maker, at least when it came to Xstrata.

Xstrata’s new head honcho saw two key factors that his predecessors didn’t have the ability to see: that commodities were on the verge of a secular bull trend, and that the merger and acquisition activities were going to change the face of the entire industry. Sure enough, Davis was right on the money, both literally and metaphorically.

In Davis’ own words, as he spoke at an investor seminar a couple of weeks ago, Xstrata transformed itself from “a company of ragtag assets into a world-class operation with world-class assets.” But then Davis also said that “the company held very preliminary discussions with rival mining companies on a range of topics of mutual interest, such as industry consolidation.”

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What does it mean in English? It means Xstrata might find itself now on the chopping block. But if so, what has changed for Davis? What does he know that the rest of the market doesn’t? After all, he has proven himself a visionary once before, which is why it might be a good idea to pay attention this time, too.

Since 2002, commodity markets have embarked on a secular bullish trend in all sincerity. By 2003, uptrends of most commodities were confirmed, at which point everyone else joined the ride. But, as was the case with every rally in the past, there was always an inevitable end, if not a bust.

Now, let me be clear, at this point, there isn’t a single analyst out there calling for a bear market in commodities. The reason why there isn’t a peep yet from anyone lies with the strong demand still being generated by China and India. But the cracks in this veneer are already showing.

Costs of production in China are rising, which is sure to put a damper on the level of demand coming from that country. While I don’t perceive China’s demand for everything and anything drying up, I don’t believe the growth rates are sustainable for much longer either, which could spell a world of trouble for Western economies. No one is ready to admit this, but in order to maintain our own economic growth rates, we need China to keep on going strong and for much longer.

Furthermore, the credit crisis in the U.S. is a problem that simply isn’t going away and that has reached global proportions. Major central banks’ bailouts (read = handouts) to irresponsible lenders and investors are forcing those same hands that “feed us” to decrease interest rates; yet, as a result of lax interest rate policies, the price levels are rising along with inflation’s ugly head. All of which can mean only one thing — recession!

In all likelihood, this is what Xstrata’s CEO is seeing ahead of us — one of the worst recessions to hit us in this many years. It doesn’t take a rocket scientist to know that recessions are unkind to commodity prices, so it could make a heck of a lot of sense to get out while prices are still high, both for Xstrata and individual investors, too.