We expect 2011 to be the year of big spending plans from the mining companies. Metals prices are soaring, borrowing costs are quite favourable, and most major miners will likely shy away from huge acquisitions after having been burned by highly leveraged transactions prior to the downturn in 2008.
Most miners are placing a huge bet on continued strong economic growth and demand for metals in China, India, and other emerging markets. Their views are supported by low per-capita consumption rates in these countries and the strong forces of industrialisation and urbanisation. On the supply side, ore grades are decreasing and world class deposits are increasingly hard to find, and labour disputes are disrupting production in the short term.
Oddly, each major miner claims that it should be able to grow its production of key metals such as copper or iron ore significantly over the next several years. Apparently, each mining company is the exception to the rule that it will be hard to grow production. Instead, we'd argue that only one of the following can be true: Either growth in global output of metals will remain constrained and prices will remain elevated while large miners will face declining production absent major acquisitions; or, mine supply will expand significantly, pushing commodity prices lower towards the marginal cost of supply.
Meanwhile, the robust prices for iron ore that have padded the pockets of mining companies have brought much pain upon steel producers. While steel production in developed economies plummeted in 2009, China reached a record high, driven by strong domestic consumption on the back of economic growth and industrialisation. This helped to hold up steel prices somewhat, but the impact has been far greater on the raw material side. China's growth in steel production, coupled with its limited domestic raw material sources, caused it to turn more heavily to global sources, most notably iron ore, which is in relatively short supply relative to global steelmaking capacity. As a result, iron ore prices have reached record levels in 2010 while steel prices are still down considerably from their 2008 peak. Given that China now represents such a large share of the steel market, fluctuations in steel consumption or production in the country have large implications for steel prices and iron ore prices, leading to significant volatility. For US steel producers, price increases have been announced recently, and early signs indicate these are taking hold, which should help the mills recoup some of the cost of higher-priced feed stock. However, production discipline will be critical for sustainable margin improvement in 2011.
See our industry-level insights for chemicals, coal, engineering & construction and metals & mining.
Elizabeth Collins, CFA, is an associate director of equity research with Morningstar.
