I love a descriptive example of applied economics. A fairly obscure Vienna, Austria-based merchant bank called MFC Bancorp (NASDAQ:MXBIF) shows in one of its recent transactions a proclivity toward extreme rationality.
This story has to do with cobalt, but it can be applied to any commodity or commodity company -- Phelps Dodge (NYSE:PD) would make the same sort of decisions regarding copper mining, Newmont Mining (NYSE:NEM) regarding gold production. When the market pricing regime prices the commodity too low, these companies put their highest-cost production on the shelf. What's instructive about the MFC example is the sheer binary nature of management's decision -- it didn't allow its mine to produce any cobalt while the market for the metal was soft. Then, when prices surged, it flipped the switch.
Cobalt prices have risen from multi-year lows as late as last year, when spot prices hovered at about $10 per pound, to recent highs approaching $30. Such a price rise is information that there are much larger demands for cobalt than there is supply. Which is a good thing for folks who produce cobalt.
MFC purchased Uganda-based Kasese Cobalt Company in late 2002, at a time when cobalt prices were still quite low. The cobalt pricing environment at the time was such that folks were on street corners giving the stuff away. So MFC bought Kasese, put it into maintenance mode, sold some power generated by the mining company's on-site power plant to defray costs, and waited for a brighter day.
With cobalt prices where they were at the time, it was more economical for MFC to not operate the mine than to operate it. It removed supply in order to address low levels of demand. Then suddenly the demand for cobalt rises, the prices rise, and what do you know, the economics of running the plant changes entirely. MFC says it will have the facility back up and running as early as next month, adding about 1,000 tons of cobalt supply into a market that averages about 40,000 to 50,000 tons per year.
So, MFC bought when the assets were dirt cheap, even though it would show losses as long as the facility remained in cold storage. Many companies wouldn't make such an economically savvy move, for fear of making their "numbers" look worse.
But wait, there's more. MFC also announced it was distributing its cobalt assets to shareholders in a tax-free transaction to be completed later this year. The company sold forward half of its cobalt production for 2004 (from the Uganda property as well as existing properties in Canada), and is essentially getting out of the cobalt business by transferring ownership of the assets to shareholders. This is a merchant bank, not a mining company, remember? Having executed a successful investment, the company is moving on.
Buy low, sell high. Operate in environments that are beneficial to shareholders. Let "the numbers" take care of themselves. That's good stuff.
