My Currency Epiphany
May 20, 2010
Coober Pedy
May 26, 2010


The Great Ocean Road

I’m on the way to Adelaide and have stopped at a coffee shop in Tailem Bend, South Australia. If you can find this place on a map, you have a better map than me. I have just driven the Great Ocean Road between Melbourne and Adelaide. I’ve driven on a lot of scenic roads before; this is clearly one of my favorites. Everyone should try to drive it at least once. Prior to that, I spent two fascinating days in the historic Bendigo and Ballarat gold fields.  I love old mining towns. There’s so much historic architecture. It’s so gaudy and ostentatious—but in an elegant way. Even though the gold has run out and much of the population has left, the towns still have a boom-times feel to them.



Downtown Bendigo

People often forget, but Australia was populated and financed by 19th century gold rushes. Without gold, Australia would only have the offspring of a few thousand prisoners and the dingos. Think of it a bit. Word comes to your small town in England that gold is found in a creek in Australia (a place you probably cannot even find on a map). You convince your family to sell their belongings and use the proceeds to buy a boat ride half way around the world in the hopes of striking it rich. You don’t even know if the information on gold is accurate, and you have no local resources if you don’t find any gold. Unlike immigrating to America, where there are farms and cities where you can get a job, Australia, at the time, barely has anything—just barren land, most of it too dry for any use. It takes a special type of individual to sign up for this adventure—self confident, resourceful and possibly crazy. A century and change later, those traits still define the Aussies.

The little town of Bendigo, in Victoria has yielded around 25 million ounces of gold by itself. In today’s dollars, that’s $30 billion dollars worth of gold extracted from just a few square miles. This little town created phenomenal wealth and capital that was reinvested all throughout Australia. There are dozens of these towns. Bendigo and Ballarat are only the two most famous. These gold booms have essentially created Australia as we know it. They’ve financed the critical infrastructure—ports, railroads and power generation. Sheep ranching will not finance that. Neither will a few wineries. Not only have these mines built up the country, they’ve created high paying jobs for generations of Australians. Heck, mining is the reason that people came to Australia in the first place. Australia never felt the economic collapse last year. Mining was the reason for that too. Unfortunately, I think the Aussies in the government may have forgotten these facts.

A few weeks ago, the Australian government proposed a mining tax that will increase the marginal tax rate for mining to something like 57%. I have read that nearly 90% of the total tax will be paid by just two companies and the majority of that by BHP Billiton (BHP: NYSE). BHP is Australia’s largest company and was formed as a result of a massive mining windfall in Broken Hill Australia. Does Australia really intend to kill the golden goose of its prosperity?

People talk about a super profits tax, as if it’s only a tax on abnormally large profits. This isn’t true really. Mining is an awful business. Until five years ago, very few mines even made any money. It was like that for nearly a decade. As a mining company, you accept many bad years as part of the business—you are really sticking around for those years when commodity prices are high and you can earn these super profits. If you knew that you would get taxed during the few good years, I don’t think anyone would even bother with mining. Then where would commodity prices be? Let’s not forget that in the good years, mining companies pay off debt and spend more on capital expenditures that have been deferred for decades.  This money is used to explore and build the next generation of mines. Mining is already a very significant contributor to Australian tax revenues. In 2009, the Australian mining industry paid A$22 billion in taxes or nearly A$1,000 per citizen. If you kill the industry, you then need to tax other industries harder to pay for bloated social programs.

Politicians are prone to do bone-headed things. You would expect this sort of idea from Bolivia, or maybe one of the Whackystans—not Australia. This really opens a pandora’s box of consequences. If Australia can tax mining like this, why can’t Mexico? What about Peru or Zambia? Governments around the world are hopelessly bankrupt. Previously, third world countries were scared to aggressively tax foreign mining firms. No one wants to be a pariah to investment.  However, if Australia can do it, anyone can do it.

On May 1, 2006, Bolivian troops barged into gas fields and planted Bolivian flags. They announced that the gas fields were now owned by the Bolivian people. They told the employees to go home and for a few weeks, the army tried to run the gas companies. Let’s just say that it was an abject failure. It takes knowhow and sustaining capital to run a gas field. You cannot just siphon off revenues. Bolivia quickly reversed course and invited the gas companies back, but with a sizable tax instead. Four years later, there is almost no spending on new production. Bolivia has earned some sizable revenues in the interim—but it still lost out in the long run. All that exploration was good for the economy. Maybe this is why they have been hesitant to nationalize their mining businesses. Nationalizations have almost always been failures. Countries rarely try it any more. Taxation is for more effective. Taxation gives you all the benefits of nationalization. You maintain jobs, skilled technocrats and the mine continues to invest for a future of very moderate profits. Excess profit taxation schemes are the new version of nationalization. As investors, we need to get used to it.

If you needed yet another reason to be very bullish on commodities—the Australian tax scheme will pretty much ensure higher metal prices in the future. Who will build a new mine in Australia? Dozens of Australian mine projects have already been cancelled or put on hold. Wait until other governments roll out similar schemes. This bull market in mining has only barely started. Without new supply, much higher prices are in the future.

For investors, this means that you must pay even closer attention to what governments are looking to do. The problem is that politicians act arbitrarily and mining is a lightning rod for their stupidity. This is another reason why I have effectively given up on investing in mining companies. All I know is that while some countries will tax their mining industries to death, other countries will welcome mining and the capital will pour into mining friendly countries, only to have mines built and then arbitrarily taxed there. This is awful for mining companies, but it is great news if you have a company that helps miners explore for minerals. You can pack up your equipment and take it to somewhere that supports mining. You can be sure that mining companies will be there actively searching for something to mine. You cannot exactly do that with an ore-body.

Of course, the Australian tax law will likely change dozens of times as they go towards a final version of it. Hopefully Australia will not commit economic suicide. In the interim, watch the Australian Dollar. It’s dropped nearly 15% since this mining tax was proposed. It will likely drop more in the next few months. Capital is scared and fleeing. 83 cents isn’t cheap enough to buy it, but in the low 70s, I’m interested to own them again—I sold most of mine in the high 80’s a few months ago. Sane minds will ultimately prevail in Australia. Even if this tax is imposed as stated, Australia has other businesses. It has more to offer as an economy. Most importantly, the Australian dollar will not collapse in the coming Western devaluations. The country is fiscally sound—even if they have odd ways of collecting revenue.

Finally, watch Australian businesses that are arbitrarily hurt by this mining tax. Whenever governments act silly, there are opportunities created. We just have to find them. I have quite a few meetings planned for next week. I hope to learn something.

Mining built Australia. Mining is the future of Australia. Right now, the Bendigo goldfield region has a fraction of the population at the height of the boom over a century ago. If this mining law is passed, most of the mining regions will suffer a similar fate—great architecture, no economic future.

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