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About the Industry
The Metals & Mining industry encompasses the extraction (mining) as well as the primary and secondary processing of metals and minerals such as aluminum, gold, precious metals, coal and steel. The industry is oligarchic in structure, with a few producers accounting for the lion’s share of the output.
The largest segment of the global metals market is iron and steel, followed by aluminum. The iron and steel segment comprises more than half the industry in terms of volume. This industry includes metal ore exploration and mining services, as well as iron and steel foundries for smelting, rolling, forging, spinning, recycling, stamping, polishing and plating of iron and steel products such as pipes, tubes, wire, spring, rolls and bars.
The precious metal and mineral industry consists of companies engaged in the extraction and primary processing of gold, silver, platinum, diamond, semi-precious stones, uranium and other rare minerals and ores, along with the cultivation of pearls.
Overall Industry Outlook
The global metal industry is cyclical, highly competitive and has historically been characterized by overcapacity (excess of supply over demand). Metal producers are subject to cyclical fluctuations in London Metal Exchange (LME) prices, general economic conditions and end-use markets.
Profitability at the individual company level depends on volume and operating efficiency. Large producers with huge resources are able to discover and develop new deposits, thereby boosting reserves, while the smaller ones own fewer mines.
Mergers and acquisitions (M&A) have historically been a critically important growth strategy for mining companies. The year 2009 experienced a lull in M&A activity under the impact of the global economic downturn and the focus shifted from business growth to business survival, as companies looked to safeguard their teetering balance sheets rather than seeking expansion.
However, reversing the trend, 2010 witnessed a surge in mining deals as the rise in commodity prices, economic recovery, demand in developing markets, growing scarcity of resources and refreshed balance sheets spurred merger activity.
2011 was a busy year in terms of M&A activity despite the European debt crisis, earthquake in Japan, social unrest in the Middle East, and downgrade of the U.S. government’s debt rating. We expect the momentum in M&A to sustain in 2012 as well. Armed with healthy balance sheets, reduced economic uncertainty and a pent-up demand for new projects, we expect the companies in the industry to accelerate deal activity with a re-focus on consolidation.
In an industry plagued with rising energy and raw material costs, increasing productivity and reducing costs are the keys to success. Given the cyclical nature of the metals industry, low-volume, high-cost producers need to generate sufficient cash or ensure a strong borrowing position during market peaks to survive the market troughs.
Continuing consolidation supports the sector’s ability to influence the price of input costs and companies can also obtain synergies and economies of scale through the operation of vertically integrated raw materials sources. Expansion in low-cost countries will ensure lower labor costs and also help tap their growth potential.
The Glencore-Xstrata merger currently in the offing is one of the biggest ever in the mining sector. If it materializes, it would result in a combined new business of $90 billion and will be the world's biggest exporter of coal for power plants and the largest producer of zinc. This will be the largest mining transaction in history, dwarfing the earlier major deals like Rio Tinto-Alcan in 2007 and Vale-Inco in 2006.
Demand in the metals and mining industry has benefitted from the strong growth in emerging markets. China and India in particular, are witnessing higher production and consumption of metals. Per capita consumption levels in both these countries are calibrating to U.S levels, which could, theoretically at least, double metal demand in the longer term.
China is the world’s largest consumer of metals and is expected to remain so in the future. Overall, we expect global metal demand to improve in the long term with the recovery of user industries.
Demand as well as production for industrial metals in Japan had been recently affected, as factories were shut down in the aftermath of the country’s strongest earthquake and tsunami. Japan is the biggest buyer of aluminum and the second largest buyer of copper ore.
We believe the industry will continue to benefit from the metal demand generated from the country’s rebuilding activity. Sovereign debt issues and sluggish growth in Europe however remain lingering concerns.
A Detailed Look into Metals
As the major shareholder (about 60%) of the metals market, the steel industry was severely bruised by the global economic downturn. But the recovery has been swift and forceful. According to the World Steel Association, world crude steel production was a record 1,527 million tons (Mt) in 2011, outperforming the 2010 record of 1,414 Mt, a 6.8% jump.
China continues to retain its status as the largest steel producing country, yielding almost half of the global output at 46%, and growing 8.9% year over year. Japan, the second largest producer country, however posted a 1.8% decline due to the earthquake. The United States remained in the third position, producing 86.2 Mt of crude steel, 7.1% higher than 2010 and comprising 6% of the total global output.
North America’s crude steel production was 118.9 Mt, an increase of 6.8% on 2010. In Asia, overall growth was noted at 7.9% and Europe rose 4.6%. As per January figures, in the current fiscal, world crude steel production was 117 Mt, a 7.8% dip from January 2011 but flat with December 2011 levels.
Reflecting on the 2011 results of the steel companies in our coverage - ArcelorMittal (MT - Analyst Report), AK Steel Holding Corporation (AKS - Analyst Report) and Nucor Corporation (NUE - Analyst Report) -- revenues increased across the board due to higher average steel prices and increase in shipments.
ArcelorMittal, the world’s largest steel producing company, produced 91.9 million tons in fiscal 2011, representing 6% of the world's steel output. ArcelorMittal’s 2011 sales increased 10% to $94 billion and for AK Steel sales climbed 8% to $6.5 billion. Nucor recorded sales increase of 21% to reach $20 billion.
In terms of profitability, Nucor stood tall with its fiscal 2011 EPS of $2.45, almost six fold the 42 cents earned in 2010. ArcelorMittal’s EPS in fiscal 2011 plummeted 31% to $1.19. AK Steel reversed its year-ago loss to earn 9 cents (excluding special items) in 2011. U.S. Steel Corp (X - Analyst Report), though still in red, narrowed its fiscal 2011 loss per share to 47 cents from the year-ago loss of $3.36.
Currently, Nucor, United Steel and AK Steel retain a Zacks #3 Rank (Hold) for the short term (1 to 3 months) that corresponds with our Neutral recommendations in the long term. ArcelorMittal retains a Zacks #4 Rank (Sell) and we have recently downgraded our long-term recommendation from Neutral to Underperform.
The steel industry had been severely affected by the global economic crisis. However, there were signs of a turnaround from the second half of 2009 which continued into 2010 and 2011 at tandem with global economic activity. Demand for steel products nonetheless remains below pre-recession levels. We expect the recovery to be slow and steady in 2012.
The steel companies expect volumes to improve in 2012 on recovering demand from improving end-markets, backed by a recuperating global economy. They expect operating results to significantly improve from 2011 levels mainly driven by improved average realized prices and higher shipments. Steel consumption is expected to grow in the automotive, transportation, energy, industrial, and the agricultural sectors.
The automotive and construction markets have historically been the largest consumers of steel. The automotive sector is showing significant promise. In February 2012, total motor vehicle sales reached the highest level since February 2008 at 15.1 million SAAR (Seasonally Adjusted Annual Rate). For the first two months of 2012, sales have averaged 14.6 million SAAR, outperforming the Street expectations.
The construction sector has been a drag on the steel companies’ earnings. However, we see some early signs of recovery in non-residential construction.
According to the American Institute of Architects, the architecture billings index, an economic indicator that provides an approximately nine to twelve month glimpse into the future of non-residential construction spending activity, was 50.9 in January 2012. The index has remained over 50 for the third consecutive month, a sure indicator of an overall rise in demand.
The optimism is seen across most regions of the country and the major construction sectors. However, given the continued uncertainty in the market, we expect soft to very moderate near-term growth in demand in this sector.
According to the data released by the U.S. Department of Housing and Urban Development, housing starts increased 1.5% to a seasonally adjusted annual rate of 699,000 in January 2012 from December 2011 and 9.9% above January 2011.
Building permits in January were at a seasonally adjusted annual rate of 676,000, 0.7% above the December figure of 671,000 and 19% above the January 2011 number. These figures provide a glimmer of hope that U.S. residential construction is finally on a road to recovery.
Based on expected economic growth from developing countries like China, India and South Korea, steel prices will be pushed up higher in the future. However, the European debt crisis and its potential global impact remain an overhang on the steel industry.
Given the scenario in Europe, ArcelorMittal has idled 5 of its 25 blast furnaces in Europe. The company will continue to align its steel growth projects to match demand situations. Furthermore, the company’s focus on its mining business given its more attractive returns has resulted in some planned steel investments being deferred.
As per the World Gold Council reports, 2011 was a milestone year for gold as global demand for the yellow metal grew 0.4% to 4,067.1 tons at an estimated value of $205.5 billion -- the highest tonnage level with a value exceeding $200 billion since 1997. The increase was mainly propelled by the investment sector, particularly in India, China and Europe.
Mine production increased 4% year over year to a record level of 2809.5 tons. However, there was a decline noted in recycling activity as consumers held on to their gold in the expectation of even higher prices. Central banks purchases rose significantly to 440 tons from 77 tons in the prior year reflecting the need to diversify assets, reduce reliance on one or two foreign currencies and rebalance reserves. Central banks have been net buyers for three straight years, the longest stretch since 1973.
Demand for gold bars and coins were robust due to the concerns raging in Europe, inflation in some countries and the unsatisfactory performance of a range of alternative instruments. The ongoing crisis in Europe has positively affected the demand for gold given the need for asset protection.
Jewelry demand was particularly strong in the first half of 2011 driven by the two major markets, China and India, due to the timing of local festivals. China and India remain the major consumers of gold, generating 55% of global jewelry demand and 49% of global demand. However, record prices in September combined with price volatility deviated customers towards other investment products.
On the whole, a 28% increase in average annual price led to an annual decline of 3% in tonnage demand in fiscal 2011. Notwithstanding this, annual demand was a record $99.2 billion.
Gold demand in the technology sector was at 463.5 tons worth $23.4 billion, a 28% increase year over year. Particular strength was noted in automotive electronics, industrial electronics and wireless equipment segments. However, the memory sector weakened considerably and is expected to remain so in 2012 as well. Severe flooding in Thailand which affected hard disk drive shipments, ongoing turmoil in Europe, and shift toward other non-precious metals also contributed to the weakness.
Gold prices in 2011 ranged from a low of $1,310 per ounce to a high of $1,895 per ounce. The record gold price of $1,895 per ounce was attained in September, 33% higher than the 2010 peak of $1,421 per ounce recorded in November 2010. Average gold price was $1,572 per ounce in 2011 compared with the prior year average of $1,223 per ounce.
So far in 2012, gold has ranged from $1,598 per ounce to $1,781 per ounce, with an average of $1,698 per ounce. Continuing concerns about Europe's financial problems and China’s reduced economic growth forecast led to the climb. Given the performance in 2011, and thus far in 2012, we expect his year to be stellar for the yellow metal.
Gold remains a coveted asset given its long-term supply and demand dynamics and influenced by macro-economic factors. Concerns regarding economic growth in developed countries made gold an attractive and safe investment option. The European sovereign debt crisis made European investors use gold as a currency hedge. Pressure on the US dollar against various currencies coupled with higher inflation expectations in many countries, including India and China, pushed up gold prices.
The value and wealth preservation attributes of gold continue to attract investors and consumers. Jewelry and investment demand in non-western markets continues to rebound while industrial demand has started to recover in response to an improvement in economic conditions. India, which alone consumes nearly 45%−50% of the world gold production, should drive demand for gold along with China. China will likely emerge as the largest gold market in the world in 2012 and Chinese gold demand is expected to double in 10 years.
Higher prices bode well for gold producers, which should benefit giants such as Barrick Gold Corporation (ABX - Analyst Report), Agnico-Eagle (AEM - Analyst Report) and Goldcorp Inc. (GG - Analyst Report). However, gold producers like Newmont Mining (NEM - Analyst Report) and Kinross Gold Corporation (KGC - Analyst Report) suffer from lower ore grades that subdue production levels, increase mining costs and negate the benefits of rising gold prices.
Ironically, rallying gold prices are not having the same effect on the share prices of the gold companies. This is reflected in our overall long-term neutral view on the space. Investors prefer alternative financial products that allow them to invest in gold rather than investing in gold companies per se that are grappling with labor issues, escalating cost and other risks.
As the major economies continue to recover, investor confidence in the stock markets will be restored, causing gold prices to fall. In reality this is not going to happen anytime soon. The stocks of Barrick Gold, Newmont Mining, Goldcorp and Kinross Gold Corporation retain a Zacks #3 Rank (Hold). However, Agnico Eagle holds a Zacks #5 Rank (Strong Sell).
The aluminum industry is highly cyclical, with prices subject to worldwide supply and demand forces along with other influences. The global economic downturn had a drastically negative impact on the aluminum industry, leading to an unprecedented decline in LME-based aluminum prices, weak end markets, fall in demand, increased global inventories, and higher costs of borrowing and diminished credit availability. The sector has however recovered from recessionary lows.
Alcoa Inc. (AA), the world leader in the production and management of primary aluminum, in response to the global economic downturn implemented a number of operational and financial actions to improve its cost structure and liquidity, including curtailing production, halting non-critical capital expenditures, accelerating new sourcing strategies for raw materials, divesting non-core assets, reducing global headcount, suspending its share repurchase program, reducing its quarterly common stock dividend and resorting to other liquidity enhancements.
For fiscal 2011, Alcoa reported adjusted earnings of 72 cents per share, reversing the year-ago loss of 3 cents per share. The company anticipates that global aluminum demand will go up 7% and burgeoning demand for aluminum along with market-related production cutbacks will lead to a global aluminum industry deficit of 600,000 metric tons in 2012.
Aluminium demand started on a strong note in 2011 but weakened in the second half. Overall, aluminium demand grew 10% in the year after 13% growth witnessed in 2010. Overall, Alcoa believes that the long-term prospects for aluminum remain bright and envisions that global demand for aluminum will double by 2020.
Market conditions for aluminum products are expected to improve globally, particularly in aerospace (10–11%), driven by rising demand for large commercial aircraft. The strong performance at the automotive sector in the fourth quarter is expected to sustain in 2012, growing at en estimated clip of 3–5%. Commercial transportation is expected to grow 2–5%, packaging in the range of 2–3% and building and construction markets in the band of 4–5%.
Region-wise, in 2012, China is expected to lead the pack with a growth of 12% followed shortly by India with a 10% rise. Asia (excluding China) is expected to record a growth of 9% and North America 3%. Russia and Brazil are expected to increase 4% and 3%, respectively. Europe, besieged by sovereign debt problems, is expected to remain flat year over year.
Since the sudden decline from peak prices in mid-2008, aluminum prices have subsequently increased. In 2010, global aluminum prices rose 13%. However, in the fourth quarter of fiscal 2011, aluminum prices plunged 27% from peak levels in April 2011. This was perpetrated by market concerns that the eurozone debt crisis could affect the global manufacturing industry and would lead to a huge downside in metals demand.
Consequently, profits for the mining companies took a blow compelling them to cut back on production. Rio Tinto announced plans to sell its aluminium assets and close its smelter in order to cut costs.
Alcoa plans to close or curtail 531,000 metric tons, or approximately 12% of its global smelting capacity, in the first half of 2012. This will lower the company’s cost position by 10 percentage points and improve its competitiveness. Energy prices and other input costs are expected to pose challenges for the aluminum industry. In addition to the curtailments, the company will step up actions to reduce the escalating cost of raw materials.
In the medium to long term, aluminum consumption will improve globally with revival palpable in the automotive and packaging industries, one of the key consumer markets. Aluminum is widely used for packaging, beverage cans, food containers and foil products.
The automobile market is also becoming increasingly aluminum intensive, benefiting from the recyclability and the light weight of the metal. Further, the surge in copper price this year is triggering a switch among manufacturers to aluminum. Automobiles, air conditioners and industrial components manufacturers are now shifting their focus on the more economical aluminum.
We expect aluminum demand to increase over the next three years, outstripping supply growth. As a result, the aluminum market is likely to see deficits for a prolonged period. This provides a backdrop supportive of high alumina and aluminum prices. China and India are undergoing rapid industrialization.
Both these factors are positive for underlying aluminum demand. Leading aluminum producers such as Alcoa and Aluminum Corporation of China should benefit from the improving demand outlook.
Currently, both Alcoa and Aluminum Corporation of China hold a Zacks #3 Rank (Hold) supported by our long-term Neutral recommendation.
Copper has become a major industrial metal given its properties of high ductility, malleability, and thermal and electrical conductivity, and its resistance to corrosion. In terms of consumption, it ranks third after iron and aluminum. Construction is the single largest market, followed by electronics and electronic products, transportation, industrial machinery, and consumer and general products.
Copper is an internationally traded commodity, and its prices are determined by the major metals exchanges – the London Metal Exchange (LME), New York Mercantile Exchange (COMEX) and Shanghai Futures Exchange (SHFE). Prices on these exchanges reflect the global balance of copper supply and demand, which can be volatile and cyclical.
Copper prices were at high levels from 2006 through most of 2008 as limited supplies, combined with growing demand from China and other emerging economies, resulted in high copper prices and low levels of inventories.
In December 2008 copper prices dipped to a low of $1.26 per pound due to reduced consumption, turbulence in the U.S. financial markets and concerns about the global economy. However, copper prices have since improved from the 2008 lows, thanks to strong demand from emerging markets and limited supply.
During the past three years, copper prices have fluctuated with LME spot copper prices ranging from $1.38 to $4.60 per pound. During 2011, LME spot copper prices ranged from $3.08 per pound to a record high of $4.60 per pound, with an average of $4.00 per pound. This rising trend has benefited copper producers like Freeport-McMoRan Copper & Gold Inc. (FCX - Analyst Report) and Southern Copper Corporation (SCCO - Snapshot Report).
Not denying volatility in prices, which would always be there, we have a bullish stance on copper prices, long term. Prices will be influenced by demand from China, economic activity in the U.S. and other industrialized countries, the timing of new supplies of copper and production levels of mines and copper smelters.
The outlook for the copper business remains positive, supported by widespread use of copper, limited supplies from existing mines and the absence of significant new development projects. Companies that have a high leverage to copper prices will benefit immensely from the potential demand for the metal in the developing markets.
Freeport and Southern Copper retain a Zacks #3 Rank in agreement with our Neutral recommendation on the shares.