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How to disembowel an economy

By Alex Cowie - posted Monday, 24 May 2010


Last week the Melbourne Mining Club held its bi-monthly “Cutting Edge Event”. This showcases small-cap and mid-cap mining companies, and it's generally the good ones that get the chance to present. It's well attended, well run, and there's no danger of missing your dinner either, as a bell lets the speaker know when their brief time slot is running out. To keep it rolling along, there's only time a few questions after each speaker.

But the night's slick operation could have been streamlined even further by posing all the presenters with the one question that investors wanted answered:

How will the proposed Resource Super Profit Tax (RSPT) affect operations?

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I couldn't have framed the question better than one particular audience member who asked:

"Great presentation! But what about the rape and pillage tax?"

This “rape and pillage tax”, if the resource industry is correct, is the proposed disembowelling of the resource sector for the good of the country. The 40 per cent “super-tax” to be levied sounds bad enough. But this 40 per cent figure sugar-coats the truth that the effective tax rate that the industry would be burdened with will be closer to 57 per cent.

This was summed up perfectly by US commentator Dennis Gartman who described it as being more typical of a South American autocrat such as Hugo Chavez. He said "Never did we expect such nonsense from Australia. Shame on Rudd, he really should know better".

Now don't get me wrong. I'm not Labor-bashing, I'm policy bashing.

Bad policies are bad policies, regardless of who cobbles them together. I have a federal politician for a neighbour and that's closer than I prefer to get to politics. For the record I don't reckon the opposition party is any more appealing. And quite frankly, choosing my favourite political party right now is a bit like choosing my favourite dental procedure.

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At the investment level, the company with the most telling observation about the tax was Rex Minerals (ASX:RXM). It's response to the question of what the tax could mean was that it's just too early to run the numbers. Fair enough. The project is in its early stages, and the tax is still far from clear.

That is the main problem with the tax and its current status: it has introduced an enormous cloud of uncertainty and doubt over hundreds of billions of dollars in Australian resource projects both large and small.

Still, life goes on in the mining world. The discussion of the shares below should not be interpreted as a recommendation to buy or sell them. I'm just reporting to you what the companies said. I'm reserving my investment judgment on resource stocks for the pages of my newsletter Diggers and Drillers.

That said, Rex is developing a copper project on the Yorke Peninsula just a few hours from Adelaide. It should have a resource figure for the project within a few months. The company says that drilling results look great. It also says there are reassuringly large, known deposits in the area.

Most of Rex's copper is close to the surface, which should make for a cheaper surface mining operation if the company gets to that stage. Being so close to Adelaide makes it easy to access rail, road, ports, power, water, as well as well as people to run the whole show, which keeps costs lower than for many far more remote projects.

The company also has a precious metals project in New South Wales with what it hopes is ten million ounces of silver, and quarter of a million ounces of gold. The managing director, Steve Olsen, said precious metals prices are looking stronger than ever, now that the major currencies of the world are "attempting to hit parity with the Zimbabwe dollar".

The second company to speak was Iron Clad Mining (ASX:IFE). It has an iron ore project also in South Australia. It is at an early stage as well but looks like it could become similar in scale to Atlas Iron's projects if the company does what it plans. The ore is already 62 per cent iron, so needs no processing, and is very low in impurities. The company is just a few months from a feasibility study (which you can think of as a mine's business plan).

Patrick Clifford, the company's General Manager, answered the tax question on everyone's lips by saying that he thinks there is "zero chance" the tax will go through in its current form, and hinted that he thought Labor wouldn't make it through the next election.

I'm thinking along similar lines, and below is what I wrote on the matter in Diggers and Drillers two weeks ago:

"The quickest way to lose a few million voters is to make them poorer."

At the last count (December 2008), 41 per cent of voting-age Australians were invested in shares off their own back. As of December 2009 the resource sector made up 33.4 per cent of the $1,400 billion total market cap for the entire Australian market. Ripping down the value of such a big chunk of the market is going to be felt in a big way by a very large chunk of voters.

As for superannuation funds, nearly ALL voters will be affected. Currently around $120 billion, or 11 per cent, of the $1.1 trillion super-fund pool is invested in our resource sector. Crippling the present and future value of the resource sector is going to make a big difference to the total value of these funds, and everyone will feel it.

With an election round the corner, the tax is not a great political move. Although he technically has until mid-April next year to hold an election, because of Victoria and NSW state elections and the Christmas break, he realistically has to hold the election before the end of October. So his campaign would need to start in September, just four months away.

The whole iron resource sector must be hoping for the same outcome. The latest casualty is Fortescue Metals (ASX:FMG) which said it was moth-balling A$18 billion worth of expansion projects until the future of the tax is clearer. In his own words Andrew “Twiggy” Forrest "can't get a banker to step up to the plate" for his new projects. If the tax goes ahead, they just won't be profitable enough. The projects go on ice until there is some clarity on what is going to happen. Forrest said "until that time, I am hoping sanity will prevail".

Add Fortescue to a long list of others shelving big projects. All up, The Minerals Council of Australia reckons about $100 billion of potential mining projects will be put on ice, although this figure is already starting to look too conservative.

About the only part of the resource sector having a good time at the moment are gold companies. My return flight from Sydney was delayed so I only caught the last few minutes of the presentation from Castlemaine Goldfields (ASX:CGT), a developing gold company in Victoria.

The price of gold is rising fast on the back of the proposed “money-printing” by the European Central Bank.

The investment banks are already raising their gold price forecasts for this year. Goldman Sachs has just increased the upper range of its forecast band for the rest of this year from US$1,200 to US$1,300.

James Turk, the founder of Gold Money, told investors at the 2010 World Mining Investment Conference yesterday that he is forecasting gold to hit US$2,000 by the end of this year (currently US$1,197), and silver to hit US$30 (currently US$18.22).

Turk's five year forecast is what stood out for me though. He is expecting gold to get closer to US$8,000 by 2015.

More than half of the current Diggers and Drillers portfolio is in precious metals (gold, silver and platinum) stocks, all of which are mining overseas thereby avoiding any potential exposure to the Rudd tax proposal. I plan to recommend another good gold stock soon, and I will be applying my usual analysis to select the best out of the five precious metals stocks that are currently ticking my boxes. Time will tell which it'll be.

But I can tell you one thing for sure right now.

I will be recommending a company that operates in an overseas country far from the government's clutches.

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First published in The Money Morning on May 20, 2010.



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About the Author

Dr Alex Cowie is the editor of Diggers & Drillers.

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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