If we could put a tape recorder in the rooms of miners, institutional investors and mining equipment companies in 2007, you would probably hear the words “commodity super cycle” frequently. The general point of view was that demand from the BRIC counties, China in particular, would increase demand for almost all commodities for 10+ years. Prices would remain high with the market for coal, copper, iron ore and other basic materials operating in deficits.
Miners ramped up capex and brought on new capacity in South America and Australia in particular throughout the past decade. While the global economy slowed down, miners pulled back but did not halt capex plans. As a result of the downturn, slower economic growth in the developed but especially the developing world, the expected shortfalls have turned into some excesses.
Prices for iron ore and some other commodities have come under pressure in 2014 and companies like Cliffs Natural Resources (NYSE: CLF), Vale (NYSE: VALE), and Freeport-McMoRan (NYSE: FCX) have had that reflected in their stock prices. Spot prices for iron ore are down by around 20% since the end of 2013. With the global economy starting to recovery, is it time to start buying the mining companies again or will they continue to underperform the market. Select long-term investments based upon the company’s exposure to different types of minerals can make sense despite the uncertain near term outlook.
Cliffs Iron Ore and Coal Exposure has Short-term Risks
Cliffs Natural Resources mines metallurgical coal and iron ore. Iron ore and met coal account for 85% and 15% of sales, respectively. The short-term outlook in iron ore as well as met coal is uncertain and has less pricing support. Demand for both of these are tied directly to global steel production.
Steel demand in China are a key driver of iron ore demand and prices. The economy there is soft and key end markets like real estate and construction have weakened. However, infrastructure and the auto industry should help but not fully offset this. Actions from the government in China could stimulate additional infrastructure related demand and turn the real estate market around. It is a wild card that would increase steel production and improve short-term ore prices.
China is important because it represents the largest wild card in short-term demand. The US and European economies are slowly improving. However, demand for steel products appears steady and does not have significant enough upside to turn iron ore prices around. However, changes in the Chinese economy could result in a positive or even negative surprise in demand and hence prices.
Without a near-term rebound in iron ore prices, it is hard to recommend the shares of Cliffs. Its earnings are very sensitive to changes in the iron ore prices. On the positive side, management is restructuring operations and cutting costs. If the market for steel and Chinese economy does start to strengthen, Cliffs could be a beneficiary through higher iron ore prices. If you are a bull on China, you should be a bull on Cliffs.
Freeport-McMoRan Copper Exposure a Concern but Benefit from O&G
Freeport is a bit of a different story than Cliffs because of the profile of its commodity exposure. While its sales are also from commodities, copper in particular, it has exposure to oil & gas and gold as well. First, the copper market may have a better level of support and may be less downside in 2014. Long-term, prices should rebound based on an improving global economy.
Copper prices are even more centered on China since it is both the marginal supplier and the marginal buyer. An economic recovery in China would help to drive higher prices by depleting inventories in China. As these inventories are drawn down, global prices would likely move higher. While China is key, the rebound in the US housing and auto markets stand to increase demand over the next few years. In addition, the slow recovery in Europe is also a positive for prices over the long-term. As a note, copper supply is a bit tighter than iron ore so margin improvements or weakness in the global economy have a greater impact on prices.
Analysts view copper prices as more stable and have a positive medium to long term view. Freeport is a leading global copper supplier with high quality assets. Also, additional production would come from brownfield projects with more attractive returns. It is also cutting costs, should benefit from subsiding political tensions at its Indonesian assets and it recently sold its Eagle Ford assets. Freeport also owns gold assets that are positive for cash flows. It has a more stable outlook for future cash flows than Cliffs and a deleveraged balance sheet following the sale of Eagle Ford assets that allow it to focus on investments with higher returns.