Rio’s $38bn investment underlines super cycle hopes for metal market

In 1958, it was called on by Lord Portal, the chairman of British Aluminium, to play the role of a “white knight” and help to defend the business from a joint bid by Tube Investments and US-based Reynolds Metals.

Alcoa ended up on the losing side then, as it did on Thursday. This time round its failure could prove costly, with traders in the City betting that either BHP or CVRD of Brazil will launch a bid for the American aluminium group.

Such a deal is likely to be priced at about $50 billion or nearly ten times Alcoa’s earnings.

This would be high enough to leapfrog Rio Tinto’s bid for Alcan and set a new benchmark as the most expensive takeover in mining history.

While the merger and acquisition buzz sparked by Rio Tinto this week dominated the headlines, dealers were as excited about what the deal suggested about the boom in commodity prices.

The feeling is that if Rio is willing to pay $38 billion to plug a hole in its portfolio of metals it is convinced the market is in a “super-cycle”, where prices will remain high and the days of boom and bust will disappear.

Mr Albanese said as much when he remarked of the Alcan deal: “This puts us in an exceptional position to benefit even more from the China story.”

Analysts have taken the signal. They believe that, with China and India buying up record amounts of raw material to feed their economies, there will be more share price gains in the coming year despite extraordinary gains in the past five.

Lehman Brothers yesterday upgraded its prices on nickel, zinc, thermal coal, coking coal, uranium, platinum, rhodium, lead and copper. It said lead should end 2007 up 38 per cent at $1.06 per pound.

Alongside the bullish forecasts, Lehman increased its share price targets for London-listed mining groups by an average of 15 per cent.

Anglo American was raised from £31 to £36. The company closed last night at £32.95, compared with £10 in July 2002.

It now has a target of £18.00 on BHP Billiton, up from £11.00 while Xstrata is £40.00, up from £33.00.

Xstrata listed on the London Stock Exchange in 2002 at 350p.

Rio Tinto’s share price dropped 2 per cent yesterday, given nerves about the sheer amount of money being spent on Alcan, but analysts are convinced the stock will recover.

The $38 billion paid for Alcan may have been $10 billion more than Alcoa had offered but it was still around the industry average multiple for recent deals of nine times Alcan’s forecast earnings this year.

Rio Tinto is confident it can squeeze $600 million of cost savings after completing the acquisition. Investors should remember that the group is currently generating $1 billion of free cashflow each month – $33 million a day.

A rerating of the sector could also mean a rally for stocks away from the mining industry’s biggest players.

Before Rio Tinto made its move on Thursday, JPMorgan advised investors to take a fresh look at the sector’s “‘laggards” in the belief that a number of firms not seen as potential acquisition targets have been forgotten and are poised for gains. It claimed that Kazakhmys, Kazahkstan’s biggest copper producer, is trading at 34 per cent below its true value despite the high copper price and set a new price target of £17.44.

The bank added that Indian-based Vedanta Resources is 20 per cent below where it should be while there is a 14 per cent upside at Swedish-based Boliden, Europe’s third-biggest copper refiner.

Increasing attention is also being paid to those further down the FTSE trading boards.

International Ferro Metals (IFM) is currently building a name for itself on the junior Alternative Investment Market.

The £550 million-rated company, which listed two years ago at 35p and closed last night at 129½p, is due to move up from AIM to the main FTSE indices in August.

It is on course to double production of ferrochrome, an alloy used in the production of stainless steel, by opening three new furnaces in South Africa and with ferrochrome prices expected to rise by about 25 per cent over the coming months should do well.

The growing noise around IFM reflects the rush to identify the next takeover target. Consolidated Minerals, which has surged in recent weeks on a bidding battle, sparked a rush among investors to unearth the next gem.

Central African Mining (Camec), the venture run by Phil Edmonds, the former England cricketer, is being reappraised by the City despite concerns over whether its takeover of fellow Democractic Republic of Congo-focused Katanga Mining will take place.

Credit Suisse on Thursday raised its price target on Camec from 120p to 150p, stating that the company was one step closer to becoming a world-class copper and cobalt producer.

Camec closed last night down 5p at 71p, reflecting fears that a deal is still some way off but major players looking to expand in the region, such as Glencor, could soon be sniffing around.

Copper-focused First Quantum Minerals is another seen as a potential target. Its shares have rocketed from 200p to £52 in the past four years.

However, for those wanting a quick profit the pick of the miners outside the sector’s Premier League remains Lonmin.

Shares in the South African-based platinum producer are at record highs of £43.00 on growing speculation that Xstrata, led by the colourful former BHP Billiton director Mick Davis, will soon launch a £50-a-share bid worth £7.7 billion.

Xstrata recently lost out on LionOre, the Canadian nickel producer, and Mr Davis is said to be ready to make his first foray into platinum. Buy.