The fact is its kind of hard to tell. If you look at their Q2 Financial results they present the data as if they are making US$76 per ton of steel, see table from their recent results:
The Sales, EBITDA and Operating Income are presumably taken on the total sales turnover of the group. Yet the same table shows iron ore production at 16.4 million tons in Q2. At current prices of some $140/ton that is $2.3bn, comparatively small beer compared to the quarter’s sales of $21.6bn but significant when looked at from the point of view of net income. Most iron ore assets have a cost of production still in the realms of the long-term iron ore contract prices of the last decade. For example Fortescue Metals, Australia’s newest major iron ore producer is reported in Business Week as having a cost of production just under $35/ton, and even that is significantly higher than the previous quarter due to the strength of the Australian dollar. Iron ore spot prices this year peaked at $180/ton and Fortescue reported an average 2010 price of $125/ton. Taking these real life numbers that suggests a crude $90/ton delta. 16.4 million tons of iron ore at a $90/ton margin is $1476m contribution to the net income. With net income for the quarter only showing $1704m that suggests nearly 90% of ArcelorMittal’s net profits come from iron ore.
Worse with the first half net income only $2383m and iron ore sales of 32.2m tons it suggests steel making ran at a loss of half a billion dollars. It raises the question is ArcelorMittal more of a mining company than a steel company? In terms of activity clearly not, but in terms of earnings per share yes it probably is. At the very least it is misleading to state income per ton of steel produced. The income on one ton of steel is way below the figures quoted.
Now we know AM are not using all the iron ore in their own steel making plants, they actively sell iron ore to third parties. Even if they were consuming all the iron ore in their own operations they would still be enjoying this huge delta between cost and market and their steel net income results should reflect this, but they don’t. At $76/ton income per ton of steel produced is below the delta achieved on the iron ore. It makes one wonder if it wasn’t for the iron ore would AM even be viable?
Maybe a more actuarially minded reader may like to run their slide rule over the numbers and tell me if I am out. The best we can do is run a comparison against competitors. US Steel is a smaller but similarly integrated steel producer currently running a loss of $25m in the second quarter according to Daily Finance even though sales more than doubled from the first quarter to $4.68bn according to the WSJ. The loss is the sixth consecutive quarterly loss for US Steel but to be fair, the WSJ makes the point that the firm has been a laggard compared to it’s peers so may be they are not an ideal comparison for the more multinational ArcelorMittal.
An FT article covers ThyssenKrupp, Germany’s largest steel maker who turned previous losses into a second quarter (their fiscal Q3) profit of $420m on sales of $16bn, but then again Thyssen is a very diversified group involved in many downstream manufacturing and engineering enterprises. However Germany’s economy has been flying this year, led by engineering and manufacturing, just the categories Thyssen’s downstream operations are involved in. One would expect Thyssen’s net profit as a percentage of sales to be higher than under-utilized steel producer ArcelorMittal, but no, AM’s return is three times Thyssen’s at 2.6% as opposed to 7.9%. We suspect therefore that AM’s results are flattered by profits on iron ore rather than the way they are presented from steel production.
We may be excused for thinking the move by miners and the Asian steel majors from annual iron ore contracts to quarterly and finally to spot (or largely to spot we have various permutations all being used at present but that’s the direction) will be the end of the iron ore pricing story, but in fact it’s just the beginning. The acceptance by CISA and the steel mills of spot pricing is moving in tandem with those same mills imposing spot pricing on their customers, essentially allowing them to pass through cost increases to their clients. For the first time in 40 years, Posco broke its annual price tariff and started adjusting prices quarterly in response to iron ore costs. We wrote last week about JFE’s evident surprise that their clients had so readily accepted a move to spot pricing, and they are not alone. While Chinese steel mills have always sold a large proportion of their material on essentially a spot basis, mills in other parts of SE Asia and in Europe have tended to adjust prices much more gradually – annual fixed prices being the norm and even longer for major consumers like automotive and consumer goods manufacturers. The semi annual adjustments that European majors like ThyssenKrupp, ArcelorMittal and Voest Alpine have imposed this year are the first step in a trend of more and more short term pricing that will manifest itself over the coming months.
You would expect howls of protest from major steel consumers and warnings that the price of a car or a washing machine are going to have to fluctuate with the iron ore market, but in fact apart from some bleating from manufacturers associations there has been a surprisingly muted response. Talking to market insiders it becomes apparent that major steel consumers are already hard at work developing hedging strategies to offset their supply price risk. Steel consumers face several closely related risks. The first is a simple agreement to index price rises and falls. If a supplier moves from annual to spot pricing, an index or benchmark is needed for agreement on prices changes, both as the price rises and to ensure fair reductions are made as index prices fall. The second risk is for the steel consumer to hedge that risk forward, ensuring a net cost balance going forward. If an automotive supplier enters into an agreement to sell steel panels to an OEM at a set price he needs to ensure his cost are controlled over the life of that pricing agreement. Over the counter iron ore swaps cleared via LCH Clearnet and SGX AsiaClear provide financial settlement of forward dated derivatives allowing consumers to essentially cover the price of steel inputs forward and more importantly by buying to an agreed index hold their suppliers accountable to price falls as well as price rises. The crucial issue here is to have the supply chain accountable to the same metric, by aligning price movements between the miner, steel mill and consumer to the same index, to hedge and reduce cost volatility.
Not surprisingly the leading players in this field like Credit Suisse are already working with major consumers such as automotive, construction and consumer durables to develop such techniques in Europe. The US is lagging behind the curve partly it seems because the integrated steel producers are more vertically integrated than Asia or European mills and therefore feel themselves less pressured to move to spot pricing, partly because scrap based EAF steel producers play such a dominant role in the US market and of course they are driven by a different set of pricing dynamics. Sooner or later however, the US will likely trend toward shorter term pricing even for major end users and ultimately hedging will become a necessity for downstream steel consumers. The interest in the Nymex MW HR coil contract when it was launched was an indication that consumers are keen for mechanisms to achieve price stability. Maybe for larger players taking one step back up the supply chain to iron ore is the way to go.
LME Week is always a great time for headlines, either announcing new projects, major players’ transactions or, what the LME loves best, market rumors! Well, a Reuters report this week covered the comments made by the veteran market trader David Threlkeld, president of metals trader Resolved Inc., regarding unreported stockpiles of copper on the world market. Or rather, not on the market but hidden from the market, because if Mr. Threlkeld is correct (and not just over-imbibing on broker hospitality) the copper market could head in exactly the opposite direction that everyone else is expecting.
Not that David Threlkeld’s comments should be dismissed lightly. As the report points out, he helped blow the whistle on the $2.6 billion Sumitomo copper scandal in the 1990s, but you have to wonder where he gets his current data.
To quote his comments in Reuters: “We ran a (copper) surplus last year … an actual production surplus. We are going to run another production surplus this year because of the deliberate rewriting of statistics to turn a surplus market into what appears to be a deficit market.” In Mr Threlkeld’s opinion, there are more than 2 million tons of unreported stocks held off warrant in warehouses where they lie unreported, most notably in China where he believes up to 2 million tons could be held.
Visible global stocks have been on a downward trend since the beginning of this year as this graph shows and while there has been Chinese growth in demand this year and a return to OECD market growth, it is difficult to judge if that level of draw-down in visible inventory is entirely due to consumption or (as with some aluminum) a move to cheaper off-market warehousing.
It should be possible to estimate China’s imports — the country imports some 80 percent of its total copper requirement, according to a Reuters video interview with Andrew Driscoll, head of CLSA’s Asia research. Add to that its domestic refined metal production to arrive at a figure to compare against its finished metal consumption, any unaccounted difference could very possibly be stocks if one could believe the figures, and therein lies the problem. The copper market was in surplus last year to some 770,000 tons according to GFMS (reported in BusinessWeek) and although China’s demand growth has been in excess of 6%pa and demand has picked up in other emerging markets, has it exceeded the surplus? Admittedly there is little precise data to reliably say the draw-down on stocks is purely for end-user consumption. The LME SHFE arbitrage window, a common driver of Chinese speculative imports, has been closed for some months yet imports have continued suggesting they represent solid end-user demand.
For the time being, most of the rest of the market is extremely bullish on copper prices, believing the market to be in deficit and the supply market destined over the medium term to get tighter as mine depletion leads to reduced supply and rising prices. Who’s right remains to be seen, but without some reliable data, for a change, we are more inclined to follow the herd.
We’re interested in what copper trends you are seeing in the market. Take our brief 4 question MetalMiner Copper Pulse survey and we’ll report back the results on Friday. [survey_fly]
We are used to hearing divergent views on metal prices, but rarely can well respected sources differ as much as we are currently hearing in the silver market. Quoted in a Telegraph article, James Turk, who founded bullion dealer GoldMoney in 2001 and is said to manage $1.2 billion of assets, thinks prices could hit $50 by the end of next year. Mr. Turk believes quantitative easing will devalue currencies and send precious metals much higher. He uses the traditional gold-silver ratio to illustrate that silver is undervalued at current prices. Simply put, the gold-silver ratio is the number of ounces of silver it takes to buy one ounce of gold. With silver currently at about $22.10/ounce and gold at $1316.25, the ratio stands at 59.56. According to Mr. Turk, in 1970 it was 20, it peaked at just under 100 in 1970 and the average is about 40, but in February 2010 it was as high as 72 when gold was high and silver exceptionally low, now it is headed back to its long-term average.
So much for the bulls; what of the bears? Well, Suki Cooper, a precious metals analyst at Barclays Capital takes a much more measured tack. While not bearish, she has an average target for silver next year of $22.20, expecting the metal to peak in the second quarter at an average price of $23.70. Silver is still in surplus, but it has benefited from safe haven buying, she is quoted as saying, meaning it has benefited this year, but don’t expect it to continue unabated.
As an Economist article points out, silver not only offers opportunities for investors keen for a safe haven, but it also offers diversity as an industrial metal. Whereas investors buy around 25-30 percent of gold, only about a tenth of global silver production goes the same way. Roughly half the world’s silver goes to industrial uses, particularly electronics and in photovoltaic cells. Demand is likely to continue to increase as economic activity recovers, particularly in Asia as where so much of the world’s electronics originate. In addition, supply, while not tight, is at least constrained by the fact that 75 percent of the world’s supply of silver comes as a by-product of copper, lead and zinc mining. So ramping up production is dependent on the economics of those metals before silver.
Having said the above, investor interest in silver, the main driver of current price strength may be waning. Ms. Cooper states in the Telegraph that in the current year to date investment inflows into silver have amounted to 1,377 tons, compared to the nine-months to September 2009 when it was 2,942 tons. It could be fear of a slowing in global growth over the next 12 months will mean industrial demand for silver will flatten out and with it investor appetite, even with quantitative easing to keep investors jittery there are no shortage of gold opportunities around for those looking for a “safe haven. The silver market has been, and remains, in surplus.
As ETF securities advised in a recent presentation to investors, Mr. Turk’s gold-silver ratio has been to the north of the 50-year average (they use 50 against the Telegraph’s average 60) for much of the last 15 years. Maybe the normal level for silver is in fact closer to the current ratio of 60, and to hearken back to an average with prices in the 1970s and 80s is misleading.
We do not pretend to have a crystal ball on the silver market, but if we had to put our hard-earned cash on the future price direction, we would suggest a large measure of volatility around current levels sounds more likely than any dramatic extension of the current bull run. Silver is not gold, and mine supply and industrial demand still play a significant role in setting the price.
A conversation this week with Wayne Bramwell, M.D., of upcoming mining junior Kasbah Resource, quickly evolved from an update on their exciting Moroccan tin mining project Achmmach to a much wider discussion of the tin market and how rapidly it is developing as an investment phenomenon.
Rather quietly and largely without great fanfare, tin has evolved over the last decade from a metal largely reliant on the traditional tin plate market to one driven by demand from cutting edge electronics and mainstream chemicals applications. Data from the ITRI shows tinplate, while important, is no longer the main driver of consumption.
As a recent analyst report points out, every laptop contains on average 32 grams of solder, which is 96% tin. Every Blackberry contains 7 grams of solder. Tin is as important to electronics as rare earths or precious metals, both of which get much more press. Demand for tin in the electronics industry makes it an integral part of the modern digital age and yet until a year or two back many in the investment community still looked at tin as a product primarily used for packing baked beans.
The level of interest in tin is perhaps understandable when we reach a little further back in time. The International Tin Council, the cartel formed in the 1950s and which finally imploded in the 1980s did much to turn the investment community off tin. Many got burned in the ensuing price collapse and the belief was probably widespread that this was a market in which a few key players could manipulate the price, hardly an attractive environment for anyone other than one of the insiders.
Consequently, investment interest in tin has lagged the rapidly changing dynamics of supply and demand. In just the last 12 months, supply constraints have become a major factor. Chinese producers have experienced a perfect storm of power restrictions, concentrate supply problems and bad weather severely restricting output at many of the world’s top ten refiners. Meanwhile Indonesia, easily the world’s most high profile, if not the largest supplier has faced declining grades, constrained investment and dwindling onshore reserves, while LME stocks, the bellwether of supply and demand, have halved this year from a high at the end of January. Standard Bank put the tin market in deficit to the tune of 6,000 tons this year and is predicting at least a 13,000-ton deficit next year. Finally, sustainability as a concept in mining has evolved rapidly in recent years from meaning not just environmental, but also to a social and political dimension. The approach that was so effective against blood diamonds is being applied to metals causing supply disruptions from the Democratic Republic of Congo just at a time when investors were being put off the country following the theft of First Quantum’s copper assets by the state.
Reading the analyst report linked above, with data taken from the ITRI, one could be excused for thinking there are in excess of twenty new projects on the point of commercial realization.
But in reality, nothing could be further from the truth. The majority of these — what the industry terms “occurrences” — are not definable resources. Even of those five or six that have been defined according to accepted standards, only four have anything like an economic future and three of those two in Australia and one in Canada — are low-grade polymetallic reserves dependent on the co-economics of the other metals occurring. The table is potentially misleading in that we do not have security of future supply it suggests, almost certainly not for the volumes that will be demanded by our increasingly digitally reliant world. One of the oldest of metals used by man has one of the brightest investment futures, for anyone with their hands on quality supplies.
Predictions made in early August by Stephen Briggs, metals strategist at BNP Paribas, that tin would move above $20,000 a ton before the end of 2010 are looking both prescient and conservative from our position today. We will remind MetalMiner readers that we did suggest buying forward tin requirements on Aug. 4, based on that analysis.
Tin prices rose this week to a two-year high, less than 10 percent below the metal’s all-time high set in mid-2008, and is showing every chance of continuing to rise further as supply constraints push the market into deficit. A Reuters article explains that tin prices have surged because of a drop in supplies from Indonesia. The country’s exports of refined tin, which account for a third of the global market, dropped 14.5 percent to 43,263 tons in the first half of the year, compared with the same period of 2009. As we covered in an article early last month, ore supplies from Indonesia have been squeezed from two directions. On the one hand, a crackdown on illegal mining in Bangka-Belitug, off Sumatra island, has reduced output and starved many small- to medium-sized smelters of raw material. Second, the long running depletion of the easily mined-on land reserves is forcing the major miners to move off-shore to dredge for alluvial deposits. Indonesia’s government said last month that the nation’s tin output may plunge 20 percent this year, blaming bad weather rather than the above for the shortfall. Production is expected to drop to about 85,000 tons compared with a full-year target of 105,000 tons.
The tin market overall had a shortfall of 9,900 tons between January and July, against a surplus of 9,500 tons in the same period last year, according to the World Bureau of Metal Statistics, quoted by The Financial Times. This has prompted a draw-down of exchange stocks resulting in tin inventories at LME warehouses falling 50 percent since the beginning of the year and are now at the lowest level since May 2009. According to a Macquerie report covered by Bloomberg this month, that puts LME stockpiles at just 5.6 weeks of consumption from 8.2 weeks in late 2009. The report forecasts the deficit at 17,000 tons this year compared with a surplus in 2009.
Meanwhile as global production expands by about 2 percent to 328,500 tons, consumption driven by solder and tin-plate demand may grow by 15 percent to 345,500 tons. The combination of falling supply, falling LME inventories, strong demand and supply concerns from other countries such as the DRC and Minsur SA in Peru will, it is believed, continue to drive the price higher making tin the metal most likely to be first to rise back above its previous all time high of US $25,500 per ton set in 2008 before the credit crisis.
As always, there is a lot of conflicting data coming out of China. Sorting what is relevant and what is not can be a challenging process. Let’s face it: China has been the main story in the metals markets for the last few years. Demand up means prices up, demand down means prices fall. But short term price movements can be misleading, sometimes showing an early sign of a longer term trend and sometimes merely reflecting a temporary change in activity. Import and export volumes have been a metric much on the radar of China watchers keen to gauge how strongly China’s economy is really performing and worried that a significant rise in imports will drive prices higher or a surge in exports will be taken as a cooling of the economy and hence drive global prices lower.
Macquarie released a recent report covered in Mineweb which looks at import/export volumes and interprets a slowing in imports as a relatively positive development in terms of price stability. The report suggests that imports of commodities are falling as more material is being sourced from domestic sources and there is also an element of de-stocking going on in the domestic market. The reduction in import volumes is happening at the same time that global demand is recovering so net demand levels are not significantly different, supporting prices current sovereign debt crisis sell-off omitting. The report says the latest production and trade data for April 2010 confirms the trend of a slowing in China’s net imports of commodities. This reflects an ongoing de-stocking in most Chinese commodities the report says, something that started in 3Q09, and also surging domestic production of commodities as imports are replaced with domestic production. Usually a statement such as net imports are falling and exports are rising is a sign that domestic demand is cooling. China was a net importer of aluminum, lead and steel over the first four months of 2009 but now it is a rising net exporter. China’s exports of flat steel products are back at peak levels, driven by a 75 percent month on month increase in hot rolled coil (HRC) exports in April. In zinc, nickel and tin, China’s net imports of refined metal have collapsed from a year earlier.
So, can we use some other measure to gauge the underlying strength of China’s manufacturing activity and better understand if this is truly a cooling of demand, or as the report suggests, a rise in domestic production? Well, one long-time measure is electricity generation. An investors’ report by Standard Bank said electricity consumption is highly correlated to manufacturing and industrial demand. These sectors tend to be the largest consumers of electricity â€?? especially in emerging market economies like China, where the primary and secondary economies contribute significantly to GDP. In China, electricity production grew at an average annual rate of 14.3 percent from 2004 to 2007. At the same time, the Chinese economy grew by an average 10.5 percent a year. China’s electricity demand growth outpaced GDP growth by around one-third in each year.
As this graph courtesy of Standard Bank shows, electricity demand has followed the same seasonal trends in recent years, but at progressively higher levels of consumption as GDP has increased. The February dip is Chinese New Year, but the interesting line is the second half of 2008 when consumption collapsed along with industrial activity all over the world. However, since July of last year, electricity generation in China has risen substantially â€?? well above levels seen in 2008. Electricity production ended 2009 at an all-time high. This pattern is consistent with China’s GDP data in 2009. Indications are that production during the five months of 2010 was also strong, although there was a small downturn in electricity generation in April (this could be seen as a seasonal drop similar to previous years).
Macquerie partially attributed China’s switch from imports to exports as a sign of supply chain de-stocking. Once complete, the strong electricity generation figures suggest demand could pick up again later in the year supporting prices in late 2010/early 2011.
Iron ore and coking coal prices have been driven up by insatiable demand from China. Steel producers the world over, but especially in Europe and Asia have suffered margin pressure due to rising iron prices driven not by their own regions’ demand but largely due to China’s. So it is perhaps a little ironic that just as European mills announce price increases to accommodate rising raw material costs, Chinese imports of iron ore and Chinese domestic steel prices begin to come off. As the following chart shows with data taken from MetalMiner IndX, Chinese domestic prices of steel products have been drifting lower since the beginning of this month.
According to Credit Suisse, iron ore prices have also weakened over the period in response to lower demand from traders on the China spot market:
In addition, producers are increasingly turning to exports to maintain capacity utilization, although not yet to the levels seen in 2006-7, but certainly an about-turn from this time last year when China briefly returned to being an importer on the back of high domestic demand for steel products.
As further evidence of cooling demand, the bank reports that steel inventories in China have increased with a build-up of both long and flat products.
Source: Credit Suisse and MySteel
One could point to a weakening of steel scrap prices in the US as evidence the recovery is going through a global dip but we are reminded of the perversion of the old saying which goes, if China sneezes the world catches a cold. For the US or Europe to pause in its recovery is to be expected and the impact is limited, but if China (the world’s engine of growth at least for metals prices) to slow could have a significant impact on iron ore and coking coal prices, finished steels and non-ferrous metals. It would pay to track China’s steel prices, inventory and iron ore spot market buys over the next few weeks to see if this is a temporary lull or part of a longer term trend of cooling growth.
The rare earth metal industry is abuzz with fresh news. We’ve covered a few of these developments over the past couple of days. The big news of the week of course involves the creation of a new rare earth metal ETF from REE Fund that will make investments in over 30 rare earth metal companies from “mine to market.” In addition, Dacha Capital announced in a press release that it had been accepted as a member of the Minor Metal Trade Association for its role in acquiring physical inventory of rare earth metals. Ordinarily (and when I first heard the news), I cringed at the thought of more financial services products coming into a space traditionally supported by the economics of industrial demand. Do we really need more speculation or financial types buying up physical inventory?
It reminds me of a conference session I ran a couple of weeks ago in which some industrial buyers of stainless steel wanted to know what if anything, industry could do to prevent “the speculators from “messing up metals markets. My response unfortunately was more of a “not much. But one of the most critical issues in rare earth metals markets involves pricing. The last major US rare earth metal producer, Molycorp, closed its doors in 2002 due to low prices from China. In other words, the US market couldn’t stay competitive based on import prices.
But therein lies the value of these ETFs and/or financial firms entering the market. By buying up inventory and taking investments in mining companies, and assuming they (the funds) can attract the capital (which we feel will happen), prices will likely increase. And when prices increase, the mining economics become a whole lot easier. We realize it stinks to be a palladium buyer right now if one isn’t hedged just as it is to be an aluminum buyer watching prices increase as stocks swell. But that lift in prices may provide the US rare earth metal industry with the help it needs to get a couple of these efforts underway, and ensure industrial buyers have more than one sourcing option. If there is anything I have learned since joining the metals industry it is this – though everyone thinks “price is king the reality is “security of supply reigns supreme.
As we said back at the beginning of March in a MetalMiner article, ferrochrome prices are being squeezed by a tight supply market limited by power shortages in South Africa, the largest producer. Even though there have been and will continue to be substantial re-starts around the world, HSBC estimates a 26 percent increase in capacity. Growing demand from the stainless steel industry is keeping pace and holds out the possibility of a market deficit next year if there are any further problems in South African power supply. The main outlet for ferrochrome is in stainless steel production and after three years of declining production and idling of mill capacity the market has now picked up across all geographic regions. A Nippon Steel & Sumikin Stainless (NSSC) official is quoted in a Reuters article as saying the European stainless industry would be back on full capacity through June of this year. NSSC is Japan’s biggest stainless steel maker. Stainless production is highly cyclical and is coming back strongly from a much reduced 2009 base over the coming year. HSBC is predicting a 9 percent year-over-year increase in ferrochrome production growth in 2010 and 6 percent in 2011 as a result of running at a deficit last year as well as robust stainless steel industry demand this year.
After rising in Q2 by 35c/lb from the previous quarter to $1.44 per lb, at their quarterly ferrochrome price fixing this month, NSCC say their primary concern was keeping a stable source of supply suggesting they too see supply constraints as an issue going forward. The European benchmark price for ferrochrome in the second quarter has increased to $1.36 per lb. This represents a 35 percent increase on the price of $1.01 per lb set in the January to March period. The benchmark was at $1.03 in the fourth quarter of 2009 and 89 cents in the third quarter, according to a Telegraph investor report.
All major producing countries are expected to show significant increases in HC ferrochrome production this year with the exception of China. HSBC is expecting South Africa to jump from 2,317,000 tons to 3,389,000 tons and Kazakhstan to jump from 890,000 tons to 1,230,000 tons, but China to fall from 1,306,000 tons to 1,000,000 tons.
Unless power worries in South Africa re-occur, we would expect this latest round of price increases to probably establish a new level for the rest of the year. At these levels, the current supply market situation is fairly well factored in along with tight but balanced stainless demand for 2010. But higher raw material costs will be reflected in stainless premiums slowing the migration from austenitic to ferritic grades and power supply issues remain a risk to the upside for prices later this year.
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