China-Australia axis turns on mining, to the benefit of both

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: Andrew “Twiggy” Forrest is not the most likely candidate to become the poster boy for Australia’s mining boom. His last big venture ended in disaster for many investors.

US bondholders who bet $400 million on an Australian nickel mining company he founded in the 1990s, Anaconda Nickel Ltd, recouped only 26 cents on the dollar. Anglo American Plc, the world’s second-biggest mining company, fared even worse. It walked away with just 7% of its $200 million investment in Forrest’s company. Today, Forrest, 46, has once again charmed investors, in Australia and beyond, this time with the promise that he’ll become one of the largest suppliers of iron ore to China.

Leucadia National Corp, a New York-based holding company with interests ranging from wine to real estate, invested $400 million for a 9.92% stake in his publicly traded Fortescue Metals Group Ltd. Russian steel billionaire Victor Rashnikov owns a 5.3% slice and plans to raise it above 15%. Birmingham, Alabama-based Harbert Management Corp already owns 15.6%. Fortescue shares were the best performers in Australia’s benchmark index in 2007, rising almost six-fold. Recently, the company enacted a 10-for-1 share split. Forrest’s 36% stake in the company was worth 7.8 billion Australian dollars ($6.9 billion) on January 4 when the stock opened at (Aus) $7.70. So far, Fortescue has not produced a single ounce of iron ore. “There’s a feeding frenzy going on over Australian resources,” says David Parker, 42, director of the Chamber of Minerals and Energy in the state of western Australia. The country’s economy has been soaring along with the global commodities boom. Emerging giants, led by China, are battling one another for a share of Australia’s natural resources to fuel their continuing economic expansion.

Australia is the world’s numero uno exporter of iron ore, coal and alumina, which is derived from bauxite. It ranks second in zinc and lead; third in gold, nickel and manganese; fourth in copper; and fifth in liquefied natural gas (LNG), according to the Australian Bureau of Agricultural and Resource Economics, a government agency. It also has the world’s biggest known uranium reserves and is the number one producer of diamonds by volume.

“Australia may be riding a commodities super cycle in which prices will rise for decades,” says Alan Heap, Sydney-based director of commodities analysis at Citigroup Inc. Per-capita steel consumption in China, with 1.3 billion people, is less than half that of other developing countries. That means it could take decades for the country’s commodities demand to slacken, he says.

Iron ore prices have tripled in the past five years. Gas prices are rising too. In September, PetroChina Co, the world’s biggest oil company, said it would buy as much as $60 billion of Australian LNG at prices estimated to be three times those China’s Cnooc Ltd agreed to pay in 2002.

Previous predictions of a super cycle haven’t always proven correct. Australian resources fuelled Japan’s industrialisation in the 1960s and ’70s. Amid the euphoria, stocks such as Poseidon Nickel Ltd soared to (Aus) $280 in February 1970 before plunging to Aus $39 the same year, when the company turned out to have less nickel than anticipated. “It was a manic phase,” says Hans Kunnen, 53, who helps manage the equivalent of $117 billion in equities at Sydney-based Colonial First State Global Asset Management, recalling that earlier boom. “This time, the question is, Is it a super cycle or just another cycle that will end in tears?” Some Australians are already suffering. Inflation hit 3.1% in 2007—above the Reserve Bank of Australia’s mandated ceiling of 3%. The benchmark interest rate, meanwhile, jumped to 6.75% from 5.25% in the first quarter of 2005, boosting the cost of home mortgages. The average Australian family has to spend 36.6% of its income to keep a roof over its head, behind only New Zealand and the Netherlands among members of the Organisation for Economic Cooperation and Development.

The rise in interest rates was one reason voters dumped the country’s prime minister of 11 years, John Howard, 68, in a November 24 general election and chose Labour Party leader Kevin Rudd instead. Rudd, 50, a former diplomat who speaks fluent Chinese, portrayed himself as better equipped to keep inflation and interest rates under control.

China, already Australia’s No 1 minerals’ customer, has become its fourth-largest foreign investor as well, with (Aus) $42 billion of projects. Chinese companies have also expressed interest in buying Australian mining firms. On December 7, Sinosteel Corp, China’s second-biggest iron ore trader, launched a (Aus) $1.2 billion bid for Perth-based Midwest Corp, trumping an earlier bid by Murchison Metals Ltd, a company backed by Japanese and Korean rivals. If successful, it would be the biggest overseas metals acquisition by a Chinese company.

That makes some Australians wary. “If an Australian company tried to become involved in a key aspect of the Chinese economy, the Chinese would block it,” says Barnaby Joyce, a senator who’s a member of the National Party, which governed with Howard’s Liberals until November.

Joyce says he will demand that the country’s Foreign Investment Review Board intervene if Chinese government-linked companies try to acquire Australian assets.