Metals Update

Recently analysts have unleashed an avalanche of upgrades for companies in the mining sector, coinciding with higher price forecasts for a wide range of metals. The main reasons for this upsurge in optimism are strong economic growth in China and an anticipated restocking of materials in developed nations.

China’s most recent industrial production number hit a yearly high of 12 percent, bolstered by strong power generation and construction data. With property and construction industries accounting for 50 percent of China’s steel consumption, it’s no secret why everyone is excited about materials.

Developed economies like France, Germany and Japan have also seen their industrial production numbers jump, albeit from depressed levels. And the US has also put up stronger numbers.

As a result, the restocking story that started with China is now expected to extend to developed economies after a year when no one needed or wanted to stock up on metals. 

The most bullish indicator right now appears to be the price of copper, which has rallied strongly.


Source: Bloomberg

At the same time, the weakness of the US dollar–the funding currency of choice–bodes well for commodities and mining stocks; prices for resources shoot up as the dollar drops, a trend that has become readily apparent this year.


Source: Bloomberg

Although the weakness of the dollar is a long-term structural trend, no one should expect the greenback to just go away. Any violent move on the downside will not be beneficial to any one. But  metals will continue to benefit as long as the fluctuations are contained and any weakness takes place in an orderly fashion.

At the same time, supply remains tight because a lot of companies have curtailed production until demand appears to be sustainably higher. Portfolio holding BHP Billiton (NYSE: BHP), for example, has slowed plans to expand operations at the Olympic Dam, Australia’s largest underground mine and the world’s fourth-largest remaining copper deposit, fifth-largest gold deposit and the largest uranium deposit. It also contains significant quantities of silver. Work on the company’s projects in central Africa has likewise slowed.

Meanwhile, Rio Tinto (NYSE: RTP) has halted work on projects in Saudi Arabia and Ghana in alumina and bauxite.

Noneconomic factors are also squeezing supply. The nickel market has suffered serious disruptions because of strikes in Canada, while the two biggest copper producers in Chile face major mine contract negotiations. The latter could prove more difficult than usual because of upcoming elections and copper’s prominent role in the country’s economy.

The big dilemma for investors is what happens if China pauses to refresh; a lot of the restocking the country has that has occurred appears to be winding down. In addition, although developed economies have been restocking, they are coming from an extremely low base–if the final demand proves to be anemic, companies will not be able to present the big profits that investors demand.

Even with these uncertainties, the supply constraint offers attractive upside. And I expect the US economy to best analysts’ expectations in the fourth quarter. If developed economies post better-than-anticipated growth in the first quarter of 2010, metals prices will head higher. Buy our metals-related picks in any pullback.

The Energy Factor in the BHP Billiton Story

Although portfolio holding BHP is one of the top diversified miners in the world, its energy exposure raises its appeal even more. The company is well placed in coal, oil, gas, and uranium markets, making it a solid play in any investment environment. BHP is the only major listed company to that boasts such a diversified energy portfolio.

Nuclear energy is of particular importance because it’s rapidly becoming an acceptable “green” energy alternative, especially in China. Conservative estimates expect China’s nuclear energy capacity to grow at a compound annual rate of 8 percent over the next 15 years.

As Elliott Gue has repeatedly point out in The Energy Strategist, energy prices will continue to increase thanks to a limited supply and ever-increasing demand in emerging markets.

BHP is also a big advocate of floating prices (as opposed to longer-term contracts) for all resources, asserting that “a floating price gives the best signal to producers and consumers about fundamentals of supply and demand.” The argument is that such a system will allow its customers to also price their end products more accurately.

The iron ore market that has traditionally been a contract market, but there’s a push to expand the floating price market. I discussed this development in my previous update on metals, Iron Fist.

Iron giant VALE (NYSE: VALE) continues to benefit from the metal’s strength.

China remains the big consumer of this commodity, accounting for 50 percent of global steel production. And as Chinese steel producers develop larger mills and move up the quality chain, iron ore (and, for that matter, metallurgical coal) will remain in high demand. Iron ore demand is expected to grow by 5 percent a year for the next 15 to 20 years.  

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