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How long until the window on rising iron-ore prices closes? Global
demand is driving prices higher and shipping costs are at historic lows. But
only companies poised to get into production quickly will be able to
capitalize. In this exclusive interview with The Gold Report, Geordie
Mark, an analyst with Haywood Securities in Vancouver, picks the companies
that are ready to profit and those that are likely to get picked off by
competitors.
The Gold Report: BHP Billiton Ltd. (NYSE:BHP;
OTCPK:BHPLF), one of the world's largest suppliers of
iron ore, recently submitted an environmental review for a proposed $48 billion
expansion of the Port Headland Harbor in Western Australia to accommodate the
doubling of iron ore production from its Pilbara operation. When a company's
willing to spend $48 billion at one operation, what does that tell us about
the long-term fundamentals about the iron ore business and, ultimately, the
steel business?
Geordie Mark: The thesis there is one of global
growth in steel demand resulting from continued industrialization from
advancing economies, particularly China. At the moment, China produces
somewhere near 45% of the world's steel.
On the back of that, India is continuing to grow its
internal steel production at greater than world average rates. So, 37% of the
world's population, which includes only China and India, has significant growth
in its underlying steel consumption and demand.
If you take a step back, these countries are both in the
juvenile stages of their steel use. They still have a long way to go in
ramping up their countrywide infrastructure requirements. This trend is
expected to continue for a number of years, if not decades.
TGR: Investors commonly think of China and India as
the primary drivers behind steel demand. However, I have a November 2010
report from UBS, which estimates that steel consumption this year will rise
by 4.5% in Europe, 4.5% in Russia and 5% in Brazil—a little bit more
than India and China. The growth forecast gets even more bullish in 2012. Are
Haywood's numbers similarly robust in countries outside of China and India?
GM: I would have to agree. China is obviously the
main source of growth due to its size. For example, China's steel consumption
is roughly eight times that of the U.S. But we are seeing significant growth
from other countries, too. There are significant growth projections coming out
of Europe, Russia and Brazil. The World Steel Association estimates global
growth this year at 5.9% and 6% for 2012.
TGR: All that competition for iron ore is driving
up the cost. China's imports of iron ore in the first quarter rose almost 15%
to about 177 million tons (Mt). Meanwhile, the average import price was
$156.50/ton in the first quarter, about 60% higher than in the year-early
period. What are some ways to play this remarkable growth?
GM: To play the growth, investors could look to
companies that are either entering into production or can enter production in
this period of high prices, which we believe will be about five years. In the
short term that could include companies entering into production this year in
order to get near-term cash flow and strong margins. An example is Labrador Iron Mines (TSX:LIM). We expect Labrador to start
production within about a month's time from a direct-shipping style
operation.
Investors could also find growth in development-stage
companies that could go into production within the window of high prices. For
example, Northland Resources S.A. (TSX:NAU) has a project it anticipates it
will start mining in late 2012 for high-quality iron ore concentrate product.
TGR: What's your prediction for prices a year out
from now?
GM: This year we are forecasting an average price
of around $139.50/tonne for 62% Fe iron ore FOB
Brazil. Next year, we forecast about $124/tonne.
TGR: Why are the prices going down?
GM: We have taken a conservative approach to
building our forward commodity price curve given known supply growth, as well
as uncertainty surrounding seaborne transport rates. Furthermore,
concordantly, the commodity has witnessed elevated pricing volatility whereby
about a year ago, the industry came off an annual benchmark approach where
the Big Three, that's Vale S.A. (NYSE:VALE), Rio Tinto (NYSE:RIO; ASX:RIO) and BHP, negotiated with steel
producers on an annual basis to fix prices. The rotation of the mechanics of commodity
pricing within this industry was a result of the underlying demand-driven
environment, which now places the iron ore producers with a lot more say in
negotiations.
World iron ore pricing rotated out of an annual benchmark
into quarterly indexing and a greater reliance on the spot price markets. In
the last first quarter and second quarter price negotiations, we have
increases in prices for the Big Three, but as stated earlier we will also see
greater volatility in the spot market relating to seasonal events and any
fundamental policy changes out of China and other growth steel producers.
Since we do see greater potential for volatility in the market going forward,
we're resting on the conservative side for pricing.
TGR: The value of companies with iron ore assets or
projects increased by an average of 400% between October 2005 and October
2010, whereas the value of metallurgical coal companies increased 34% during
that same time, according to the UBS report. Steel companies were up 12%
during that period. Part of that value creation is because steel companies
have gone upstream and bought iron ore juniors to control the cost of supply.
Do you expect that trend to continue?
GM: I would say the valuation metrics driving steel
companies and companies with iron ore assets differ appreciably given that
the steel companies work on operating margins and output growth, whereas
companies with iron ore assets and projects have moved up because they're
increasing the underlying resource base, lowering apparent risk by moving
through development or entering production in a market with elevated
commodity prices.
We do see vertical integration being a very significant
component going forward for the steel producers. Steel producers want to
hedge away from the Big Three. These companies want to be independent and
integrate their cost management into locking up some of their iron ore at
cost. Such integration enables steel companies to be more competitive when
selling steel. We believe that there is likely to be continued vertical
integration in the sector as steel producers lockup supply and protect the
underlying cost base.
TGR: One example of that was when Cliffs Natural Resources Inc.
(NYSE:CLF) bought Consolidated Thompson Iron Mines
Ltd. (TSX:CLM)
GM: That's exactly right. Cliffs and Consolidated
Thompson have a lot of operational synergies in the Labrador Trough. Cliffs
was able to pay a good price for Consolidated Thompson. The Canadian
operations had operational synergies, so that arrangement worked for Cliffs.
Another example of vertical integration would be Tata Steel Ltd. (LSE:TTST; Grey Market:TATLY) forming a joint venture with New New Millennium Capital Corp.
(TSX.V:NML) on a direct-shipping ore project in the Schefferville-Labrador Trough, as well as participating
in a bankable feasibility study on New Millennium’s large taconite
deposits near Schefferville.
There is good vertical integration potential in the
sector, particularly within areas that have existing infrastructure or reasonable
assurance in terms of asset ownership. Canada is a very good home for such
activity.
TGR: You recently revised your price target on Alderon Resource Corp. (TSX.V:ADV; OTCQX:ALDFF) from $3.90 to $5.80 after
it published a resource estimate on its Kami iron
ore project in Labrador. Was it the size of the estimate that made you revise
your target?
GM: We were pleasantly surprised by the resource
estimate. Alderon reported an Indicated iron ore
resource of 490 (Mt), plus an inferred resource of 118 Mt. Just today, the
company brought out some drill-hole results on North Rose, which is outside
the defined resources, and looks as though it has potential to add resources.
Alderon did surprise on the upside and we give it
some more credit on that basis.
TGR: What were your thoughts after visiting the
property and meeting management?
GM: My take is that the management is made up of
very strong group, and this is married with a very strong board. A
significant component of the current board is that many were also on the
board of Consolidated Thompson during its pre-production stages.
In terms of the property, it's all location, location,
location for infrastructure. The Kami property is
within 15 miles of four operating mines with four options to get to a public
rail system. Those components work well together for this project.
TGR: Would those factors make it a takeover target?
GM: It has potential. The main other component is
that it is independently owned. There are no steel producers involved in the
company at the moment. Its largest shareholder is Altius Minerals Corporation (TSX.V:ALS) because it originally held the property.
I definitely think Alderon could be a potential
takeout candidate in the long term.
TGR: Are there some other promising juniors that
you follow?
GM: Another independent iron ore company in that
same mining area is Champion Minerals Inc. (TSX:CHM). It has a portfolio of projects
with around 1.5 billion tons of NI 43-101 compliant resources. Its flagship
project, Fire Lake North, is not too far away from ArcelorMittal (NYSE:MT) existing Fire
Lake Mine. Champion potentially still needs a little more infrastructure to
come into play, but it has a very good portfolio of assets going forward. We
have a target of $4.20 for Champion stock. Recently, it was trading at about
C$2.38.
TGR: Any other juniors in the Labrador Trough
there?
GM: I mentioned Labrador Iron Mines, which is
entering production this year. It probably will produce just less than 1.5
Mt. of 62% direct shipping iron ore style product.
TGR: Who are the major shareholders in that play?
GM: The main shareholder is Anglesey Mining Plc. (LYSE:AYM). The second major shareholder is
Passport Capital.
There is also New Millennium Capital Corp., which has a
joint-venture project with Tata Steel, its largest shareholder.
TGR: Given Tata's large stake in New Millennium,
it's probably not a takeover target. But are Champion and Labrador?
GM: Alderon, Champion and
Labrador all have the potential to be taken out.
We are also looking at Northland Resources being one of
the next producers, although it isn't in the Labrador Trough.
TGR: Where is that project located?
GM: It has two projects. Its flagship is the Kaunisvaara project in Sweden, which is fully permitted
for production, and is in development at the moment.
Sweden has a long history of iron ore mining. This project
would export out of Norway, and would probably be predominately selling to a
European market. The project is expected to output a very high-quality
product at around 69% Fe, and we think the company could fetch a good premium
for the product.
TGR: What can investors expect in the iron ore
market in the near term?
GM: Growth should continue to emanate out of China
and India, and bolstered recovery is taking hold in Europe, particularly
Eastern Europe, and North America. Another feature to look at is the cost of
seaborne freight. There have been continuous lows in the market for seaborne
freight because of surplus capacity that should continue for a number of
years. Demand growth and lower transportation rates provide fantastic
opportunities for pricing protection to moderate operating margins for
projects entering production or at the development stage.
TGR: Thanks for your time, Geordie.
Dr. Geordie Mark, a research analyst with Haywood Securities, focuses on
uranium companies involved in exploration, development and production. He
joined Haywood from the junior exploration sector, where he was vice
president of exploration for Cash Minerals, which concentrated on uranium and
iron oxide-copper-gold targets across Canada. Prior to joining the
exploration industry, Mark lectured in economic geology at Monash University, Australia, and served as an industry
consultant. He completed his Ph.D. in geology in 1998 at James Cook
University's Economic Geology Research Unit in Australia, specializing in
aqueous geochemistry and igneous petrology applied to ore-forming systems.
DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this
interview. He personally and/or his family own shares of the following
companies mentioned in this interview: None.
2) The following companies mentioned in the interview are
sponsors of The Gold Report: Commerce, Great Panther and Kent.
3) Leonard Melman: I personally
own shares of the following companies mentioned in this interview: None. I
personally am paid by the following companies mentioned in this interview:
None.
The Gold
Report
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