Mergers hotter than ever

The hottest mining news this summer concerns the fight for control of two Canadian nickel giants, Falconbridge and Inco. Inco wants Falconbridge; so does Xstrata. Teck Cominco wants Inco; and Phelps Dodge would take both Inco and Falconbridge. My inbox is full of news about who has upped the ante just a little more and suggestions about what investors should do.

Two years ago the merger-go-round was spinning over the proposed takeover of Wheaton River by IamGold. Glamis Gold got into the act, and Wheaton was finally rescued by Goldcorp.

Merger mania has now infected companies of all sizes. The number of announced mergers between smaller players would need a week’s research to pin down accurately.

What is it about the last two years that has made mergers and takeovers so attractive? In three words, “high commodity prices”. Individual year-over-year increases are good, and prices in 2006 remain strong. The yearly average price of export metallurgical coal rose 73% from 2004 to 2005. During the same period, the average zinc price was up 32%, copper jumped 28%, iron ore increased 71%, gold and silver rose 9% and 10% respectively, and nickel rose 7%.

Most metal prices have continued to rise in 2006. By the third week of July, the nickel price had more than doubled to US$13.00/lb from US$6.00 at the end of December 2005. Gold was trading at US$640.00/oz, up from US$513.60 at the end of last year; silver hit US$11.00/oz, up from US$8.83. Copper rose to US$3.60/lb from US$2.10, and zinc hit US$1.50/lb up from US$0.87. Uranium has doubled since the end of 2005: uranium oxide now commands US$45.50/lb, compared with US$21.00/lb.

High prices attract high rollers, but increased revenues for miners do not ensure higher earnings. Already producers are paying more for materials, supplies, labour, transportation and fuel. Such costs quickly eat into profits. This rate of price growth can only be sustained as long as commodity prices keep rising.

Mining is a cyclical industry. While it is unusual for the prices of so many commodities to be so high for so long, all at the same time, they will drop at some point in the future. Whoever makes the best bid and wins the hand of Inco and Falconbridge this summer might not look like such a winner when the next downturn arrives.