Investor's Business Daily, April 20th, 2007
Chunks of zinc, nickel, cobalt, bauxite and copper would be an awesome addition to any kid's rock collection.
Collect enough of it and you can build cars, airplanes, ships and cities. It's the bedrock on which humanity was built.
Today, demand for metal ores is stronger than ever, generating very good times for the companies that mine and process the metals into stainless steel, aluminum, iron, special alloys and much more.
"Prices are through the roof," said John Mothersole, a research analyst at Global Insight.
Copper, after hitting an all-time high of $1.55 a pound in 2005, soared to a high of $4 last year before settling back to a still-solid $2.50 a pound.
"If someone said in 2003 that you'd be paying more than $2 a pound for copper today, they would have looked at you funny," Mothersole said.
Metal prices have been rallying for five years. Prices of iron ore and nickel hit all-time highs this year.
Many of the stocks of the metals ores industry group are at all-time highs as well. They include BHP Billiton BHP, which mines copper, iron ore, aluminum and coal; Rio Tinto RTP, with global interests in mining, metals and industrial minerals; Freeport McMoRan Copper & Gold FCX; and Southern Copper PCU.
1. Business
The metal ores industry group consists mainly of mining companies that continuously scour the globe for ore deposits and metals. The ores are extracted from earth and processed into useable materials.
Bauxite is converted into aluminum. Zinc is used to galvanize steel and to make brass. Cobalt is used to develop high strength alloys, for batteries and for the production of inks and paint. Lead has a wide range of uses, from building construction to bullets. Copper has been in use as far back as 2000 B.C. in China.
Alcoa AA, Alcan AL, BHP and rivals are projected to spend more on mining exploration this year than last year's record $7.5 billion, according to the Metals Economics Group. Exploration spending has increased each year since 2002, the bottom of the last cycle.
Exploration budgets steadily increased through the early 90s to a crest of $5.2 billion in 1997, according to MEC. It then fell for five straight years to a 12-year low of $1.9 billion in 2002. This 63% drop since 1997 set the stage for the current boom.
Partly due to a Chinese economy that has doubled in size over the past decade, miners have been unable to meet demand for copper, nickel and other metals. With demand high and supply short, metal prices have soared.
Miners are working actively to move new projects up the pipeline, but not fast enough to meet current demand.
"There are not a lot of huge projects coming on stream," said Leo Larkin, equity analyst at Standard & Poor's, "And even if they discover large deposits, the time it takes to get permits and the gestation period is a lot longer than it used to be."
Name of the game: Continuous exploration of mining of materials must be balanced with rigorous investment discipline and maneuvering through a complicated maze of regulations, taxes and politics that vary from region to region.
2. Market
As the global economy goes, so goes the business of mining metal ores. The booming economies of China and India in particular have created strong demand for metals. China's economy expanded almost 11% last year, the fastest clip in 11 years, and is projected to grow another 8% this year.
Chip Goodyear, chief executive of BHP, noted the trend in the company's 2006 annual report.
"China is determined to become a knowledge economy by 2050," he wrote. "To achieve its vision, hundreds of millions of people will need to move from rural to urban dwellings, industrial facilities and associated infrastructure. All the raw materials that we produce and sell are essential elements of these infrastructure requirements."
A primary industry concern is what direction the U.S. economy is headed.
Declining auto sales and production and a downturn in housing markets have restrained economic growth.
But strong growth in other hot spots around the world and improving conditions in Europe have more than made up for the U.S. slowdown.
Alcoa, the first major miner to post first-quarter 2007 results, reported its most profitable quarter ever earlier this month, which the company attributed to higher metal demand from China and the global aerospace and construction industries.
3. Climate
World demand for aluminum rose 7% in 2006 and is forecast to rise another 7.5% this year.
The price of metals can gyrate wildly due to all manner of events, including severe weather and political upheaval. The price of aluminum was $600 a ton in early 2006.
It plummeted to $200 as additional capacity came online but rose to $300 due to political strife that caused a worker strike in the Republic of Guinea, a major area of bauxite exploration.
Also applying pressure on miners is the rising cost of drilling and assaying. That's partly a result of higher fuel costs and a shortage of scientists.
Moreover, the low-hanging fruit has been picked. Exploration is now moving into regions perceived as having higher political risk. Lower-risk countries are already well explored.
According to the "World Exploration Trends" report issued in March by the Metals Economic Group, exploration allocations in Venezuela fell 40% in 2006 after the industry fell under state control, dropping the country from sixth place in Latin America to 11th. And investor fears of similar moves by other Latin American countries or in Africa and central Asia, will likely dampen exploration growth.
Latin America received the largest share of exploration budgets in 2006 with 24%, followed by Canada at 19% and Africa at 16%.
Shifting tax and regimes in Latin America and southern Africa "may slow future growth, as some governments in these regions look for a greater share of increased mining company revenues," the report said.
4. Technology
The aluminum industry has been on the cutting edge of technology development in the metal ores industry, part of an effort to reduce the high amount of energy used in production. Companies are also investing more in pollution control and reducing greenhouse gases that cause global warming. (See related story, this page.)
Between 1990 and 2005, aluminum producer Alcan cut emissions 25% while boosting production 40%, according to CEO Richard Evans.
Energy is a major portion of aluminum production costs. Alcoa, with sales of $23 billion, spent $2 billion on energy last year.
The Aluminum Association and the U.S. Department of Energy Industrial Technologies are jointly working on a technology to increase energy efficiency and cut production costs for the aluminum industry.
It has led to more than $100 million in joint research and development projects involving more than 75 partners from the industry, suppliers, universities and private research organizations.
5. Outlook
According to Paul Skinner, chairman of Rio Tinto, constraints that have limited supplies of most metals and minerals will continue into 2007. In a February conference call, he suggested that further growth will involve more capital spending.
"With most of the industry now operating at or close to capacity, substantial investment will be required to increase production volumes further," he said.
He added that a shortage of new large ore bodies, equipment and skill will squeeze production and raise costs.
Still, he added, global economic growth in 2007 looks set to exceed a strong 4%, which will lead to continuing strong demand for metals and minerals.
Inventories remain low by historical standards, which should keep prices well above long-term averages.
Upside: Although some metal prices have dropped from recent highs, prices will likely remain historically strong as long as demand remains high enough to maintain the supply-side imbalance the industry has thus far been unable to correct.
Risks: The industry's rate of growth might be restrained by a shortage of skilled personnel and equipment as miners launch plans for large scale projects to replace depleted reserves and catch up with booming demand.
