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A Brief Overview
The Metals & Mining industry broadly refers to metals and minerals extraction (mining) and the primary and secondary processing of these metals and minerals. The industry is oligarchic in structure, with a few producers accounting for a lion’s share of the output.
With respect to volume, iron and steel commands a majority in the global metal industry, followed by aluminum. The iron and steel 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.
The precious metal and minerals industry comprise companies engaged in the extraction and primary processing of gold, silver, platinum, diamond, semi-precious stones, uranium and other rare minerals and ores as well as cultivation of pearls.
The industry is highly cyclical and competitive. Historically, it has suffered from oversupply (excess of supply over demand). Metal producers are subject to cyclical fluctuations in prices, general economic conditions and end-user markets. The tepid global economic growth outlook has emerged as a major headwind for the global metal industry. Notwithstanding these near-term challenges, the group’s long-term dynamics appear attractive.
Within the Zacks Industry classification, the industry is broadly grouped in the Basic Materials sector (one of 16 Zacks sectors) and is further sub-divided into three industries at the expanded level: Mining – Gold, Mining – Iron and Mining – Non-Ferrous. All the industries within the Basic Materials sector like chemicals, paper, steel and mining are economically sensitive, but the level of sensitivity and exposure to different stages of the economic cycle vary for each industry.
We rank all of the more than 250 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank http://www.zacks.com/rank/industry.php.
The way to look at the complete list of Zacks Industry Rank for the 250+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #170 and higher) is negative.
For the Mining Industry, Iron Mining barely makes into the top 1/3rd with its Zacks Industry Rank #77, while the Non-Ferrous (aluminum, copper, etc.) and Gold Mining industries are barely in the bottom 1/3rd at Zacks Industry Rank of #187 and #182, respectively. The exact location of the three mining industries on the Zacks Industry Rank aside, one could safely say that the near-term outlook for the group is leaning towards a Neutral outlook.
A Detailed Look into Metals: Performance and Outlook
The steel industry has steadily recovered from the impact of the global economic downturn, which slashed crude steel production by 9% in 2009. According to the World Steel Association, world crude steel production was a record 1,548 Mt in 2012, outperforming the record set in 2011 by 1.2%. Significant growth in Asia and North America were instrumental for the annual upside, marred somewhat by declines in Europe and South America.
During 2012, production in Asia improved 2.7% to 1,012 Mt. China emerged as the leading steel producing country once again, up 3.1% year over year and yielding almost 46% of the global output. Production in Japan, the second largest producer, remained flat year over year. The United States held the third position, producing 88.6 Mt of crude steel, up 2.5% annually and accounting for 6% of the total global output. Production in Europe and South America were a dampener, declining 2.7% and 3.1%, respectively.
Let’s have a look at the performance and outlook of the end markets for the industry:
The automotive and construction markets have historically been the largest consumers of steel. The automotive sector has been promising in recent times. Auto sales in the U.S. surged 13% to 14.5 million vehicles in Dec 2012, the highest volume attained in the last five years. The seasonally adjusted annual rate (SAAR) in December was 15.4 million vehicles, the second straight month of above 15 million SAAR in 2012. This performance will likely generate solid momentum going into 2013.
The robust growth rate in the sector has been fueled by strong pent-up demand, cheap financing, launch of several redesigned and fuel-efficient vehicles and rebound in consumer confidence thanks to a growing belief that the housing market is recovering.
Another major market, the construction sector, has so far been a drag on the steel companies’ earnings. However, in 2012, the sector finally started picking up began signaling a recovery evidenced by solid growth in the major indicators.
The architecture billing index (ABI), an economic indicator that provides an approximate nine- to twelve-month glimpse into the future of non-residential construction spending activity, climbed back into the positive territory with a score of 50.2 in August after languishing in the negative territory for five consecutive months. Any score above 50 indicates an increase in billings and the score has remained stable till December.
The ABI readings in the fourth quarter of 2012, in fact, exhibited the strongest growth since the downturn in early 2008. This momentum is expected to persist and conditions are expected improve, albeit at a slow and steady rate.
The American Institute of Architects projects a 5% increase in spending in 2013 for non-residential construction projects, on the back of higher construction of commercial facilities, particularly for hotels followed by industrial construction spending. The spending is expected to shore up to 7.2% in 2014.
Meanwhile, the residential housing sector is also showing signs of positive growth with figures at highest levels in more than four years. In 2012, housing starts totaled 780,000, surging 28% from 2011 and housing permits (an indicator of future demand) escalated 30% to 813,000. Both attained their respective highest level since 2008. Housing completions rose 11% to 651,000 in 2012, the highest level since 2010.
According to the most recent most issued data, in December housing starts spiked 37% year over year to a seasonally adjusted annual rate of 954,000. Building permits were at a seasonally adjusted annual rate of 903,000, 29% higher than the year-ago figure.
In a nutshell, record-low mortgage rates, rising rents and reduced prices of properties are luring buyers. These figures reinforce the belief that U.S. residential construction is finally stabilizing and is on the road to a much awaited recovery.
Analyzing the fourth quarter results of the major steel companies in our coverage -- ArcelorMittal (MT - Analyst Report), United States Steel (X - Analyst Report), Nucor (NUE - Analyst Report) and AK Steel (AKS) -- we see revenues were marred by the drop in average steel prices. This does not come as a surprise as oversupply in the U.S. steel industry and increased steel imports in the domestic market affected steel prices, which in turn hurt margins and profits of the steel players. Furthermore, the gloomy macroeconomic condition in Europe is another area of concern as it is the largest market for total U.S. exports.
Given the scenario in Europe, ArcelorMittal, the world's largest steelmaker in terms of volume and Europe’s largest steelmaker, recently announced its plans to permanently close its plant in Liege, Belgium owing to the slack demand and weakening European economy. The company also announced the idling of its liquid phase in Oct 2011 due to structural over-capacity in Northern Europe. The production halt at the Liege plant was done to better focus on the company’s downstream activities, operating five core lines and seven flexible lines.
However, economic conditions worsened since then and demand for steel in Europe declined another 8%-9% in 2012 and is currently 29% below the pre-crisis levels. The Leige business is heavily dependent on the automotive sector, which faced a major downturn in 2012. Consequently, tepid demand also had a hand in idling of the facility and ArcelorMittal further stated that it will close six production lines at Liege that manufacture finished steel products for the auto industry. It is also closing a coke plant, which produces fuel for blast furnaces.
Going into 2013, steelmakers expect profits to be affected by continued increase in steel imports, volatility in steel pricing along with macroeconomic uncertainty stemming from the recessionary conditions in Europe and sluggish growth in the emerging markets.
However, the sector will benefit from the strong momentum in the automotive markets. The outlook for other key markets -- transportation, energy, industrial and agricultural sectors also remains favorable. The turnaround in the so-far faltering construction sector will definitely provide a much-needed impetus to the sector.
Steelmakers are increasing their consolidation efforts, particularly in China and India, to derive economies of scale and other synergies to remain competitive. A major development in this sector was the recent merger of Japan's largest and the world's sixth-largest steel maker Nippon Steel Corporation with Sumitomo Metal Industries to form the world’s second biggest steel firm -- Nippon Steel & Sumitomo Metal Corporation (NSSMY). With a combined capacity of 46.1 million tons, it has replaced China's Hebei Group in the second position, with production of 44.4 million tons. The merger is targeted to generate savings in the face of increasingly intense global competition.
China’s recent attempt to bolster its economy by approving 60 infrastructure projects worth more than $150 billion will help bolster the steel sector. Prices could potentially stabilize on the back of a rebound in construction activity in the developing countries, in particular China, India and South Korea. Furthermore, the sector will reap the benefits of the Federal Reserve’s move to boost the U.S economy. However, the European debt crisis and its potential global impact remain headwinds for the industry.
As per the World Gold Council, 2011 was a milestone year for gold as global demand for the yellow metal scaled up 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 driven by the investment sector, particularly in India, China and Europe.
As per the most recent data available, gold demand stood at 1084.6 tons in third quarter 2012, down 11% from the historic high level in the third quarter of 2011. Strong ETF inflow and higher demand from central banks was offset by declines in demand for jewelry, investment and in the technology sectors due to higher prices. Almost 68% of the decline stemmed from a steep drop in the bar and coin segment.
In absolute terms, gold demand in the quarter was valued at $57.6 billion, down 14% from the third quarter of fiscal 2011. Average gold price in the quarter stood at $1,652, down 3% year over year.
Central banks remained the primary purchasers of gold, accounting for around 9% of total gold demand at 97.6 tons. Investment demand declined 16%, mainly due to a drop in bar and coin investment. Gold demand in the technology sector was 108.2 tons, a 6% annual decline due to higher gold prices, weak consumer demand, uncertainty in Europe and substitution to more affordable alternatives.
Jewelry demand dipped 2% to 448.8 tons due to higher price levels as well as unfavorable economic conditions. China, Saudi Arabia, US and European markets saw declines. On the contrary, jewelry demand was strong in India, a major consumer of gold and accounted for 30% of global demand. Despite record high prices, demand was on the rise thanks to improving sentiment, stock building and positive price expectations.
Demand for gold in China, another major market, decreased 5% to 123.8 tons as consumers cut back spending given the slow economic growth. Demand in the U.S market was affected as customers are trending toward lower carat gold, particularly with the penetration of 10-carat and other alternative metals.
Mine production dipped 1% to 731.6 tons in the quarter. Mine workers’ strike in South Africa, disappointing results for a number of operations, lower-than-expected growth at new or recovering mines affected production during the quarter. Recycling activity decreased 2% to 460.7 tons, bringing the total supply to 1,188.3 tons, down 2% year over year.
Gold prices in 2011 ranged from a low of $1,310 per ounce to a high of $1,895 per ounce, with an average gold price of $1,572 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 in November.
In 2012, gold prices have has ranged from $1,540 per ounce to $1,791.75 per ounce, with an average of $1,669.03 per ounce. Gold prices had a solid run in the first three quarters of 2012. Continuing concerns about Europe’s financial problems and China’s reduced economic growth forecast led to the climb.
Furthermore, the announcement of a third round of quantitative easing led to a surge in gold prices. However, in the fourth quarter, prices fell from $1,776 per ounce to $1,657 per ounce, a 6.7% drop. Despite a weak fourth quarter gold stood at $1657.5 per ounce at 2012 end, up 8.3% and marked the 12th year of annual gains.
The official sector is expected to continue to be a net buyer of gold in 2013. However, high gold prices and economic uncertainties will likely keep a check on demand for jewelry. Demand in the technology sector will be dampened due to high prices and the shift toward lower cost substitutes.
A climb in gold prices has not always translated into increased revenues for all the gold miners, as they have to deal with increased cash costs and production issues. As prices for gold rise further, gold giants such as Barrick Gold (ABX) and Goldcorp (GG - Analyst Report), being unhedged producers of gold, will enjoy significant leverage to gold prices.
The cost increases need to be controlled in order to rake in profits. On the other hand, gold producers like Newmont Mining (NEM - Analyst Report) and Kinross Gold (KGC - Analyst Report) are expected to suffer from lower ore grades that subdue production levels, increase mining costs and negate the benefits of rising gold prices.
Ironically, rising gold prices has not had the same effect on the share prices of the gold companies. Investors prefer alternative financial products that allow them to invest in gold rather than investment in gold companies per se. These companies may be entangled in labor issues, escalating cost and other risks.
Gold remains a coveted asset given its long-term supply and demand dynamics and influenced by macroeconomic factors. The value and wealth preservation attributes of gold continue to lure investors and consumers, and is considered a safe investment. Concerns regarding economic growth in developed countries have made gold an attractive and safe investment option.
Gold prices will continue its rally in 2013, driven by investment and buying of gold by the central banks as a reserve portfolio asset. Strength in Indian markets, which alone consumes nearly 45%−50% of the world’s gold, should also provide support.
Furthermore, recovery in China could contribute to the rise in the prices of gold. The Eurozone debt crisis and the geopolitical risks in the Middle East will pose as important drivers for a sustained demand for gold as a safe haven.
The aluminum industry is highly cyclical, with prices subject to worldwide supply and demand.
Alcoa (AA), the world leader in the production of primary aluminum, kicked off the fourth quarter earnings season with a revenue decline of 1.5% due to lower realized metal price. On an adjusted basis, the company reported earnings per share of 6 cents reversing its year-ago loss of 18 cents per share earned in the year ago quarter. The company’s midstream and downstream businesses delivered profits and its cost-cutting measures also supported the results.
Alcoa is optimistic for 2013 and expects global demand for aluminum to increase 7%, up from 6% growth in 2012. The company projects 9%-10% global growth in the aerospace sector this year. Its growth forecast for the other markets are -- automotive (1%-4%), commercial transportation (2%-7%), packaging (2%-3%), building and construction (4%-5%) and industrial gas turbine (3%-5%). Alcoa remains firm on the long-term prospects for aluminum and envisions global demand for aluminum to double by 2020.
Alcoa’s positive long-term outlook notwithstanding, prices have been under pressure, prompting companies to cut back on production. Alcoa’s results have suffered because of the decline in realized aluminum prices. BHP Billiton (BHP - Analyst Report) and Rio Tinto (RIO - Analyst Report) have either sold or halted development of aluminum projects following a decline in aluminum prices.
In 2012, BHP sold its 33.3% stake in the Guinea Alumina joint venture to its partners and also halted bauxite exploration at its Boffa-Santou-Houda site in Guinea. The company also abandoned plans to build a smelter in the Democratic Republic of Congo. Rio is set to divest 13 aluminum assets, including its Gove operations in Australia. Alcoa is looking to buy mines used in the manufacture of aluminium from BHP Billiton and Rio Tinto.
Alcoa is aggressively slashing costs and pursuing strategies to move down its cost curves in its upstream businesses. The company remains committed to achieving its target of moving down the cost curve 10 percentage points in smelting and 7 percentage points in refining by 2015. The company completed planned closure or curtailments of 531,000 metric tons, or 12% of its highest-cost system smelting capacity, to enhance its competitive position.
This trend will likely continue until aluminum prices recover. Energy prices and other input costs are expected to pose challenges for the aluminum industry, though oil prices have been on the downside lately. In addition to the curtailments, the company will step up activities to reduce the escalating cost of raw materials.
In the medium to long term, aluminum consumption is expected to improve on a global basis. The revival is palpable in the automotive and packaging industries, one of the key consumer markets. The automobile market is also becoming increasingly aluminum-intensive, benefiting from its recyclability and light-weight properties. The global push to improve fuel efficiency in vehicles is expected to more than double demand for aluminum in the auto industry by 2025.
Further, the surge in copper prices last year has triggered a switch among manufacturers to aluminum. Automobiles, air conditioners and industrial components manufacturers are now shifting their focus to the more economical metal. In response to the upsurge in automotive demand, Alcoa has invested $300 million in expansion projects at its Davenport, Iowa rolled products plant.
We expect aluminum demand to increase over the next three years, outstripping supply growth. As a result, the aluminum market is likely to witness deficits for a prolonged period. This provides a backdrop supportive of high alumina and aluminum prices. China and India are witnessing rapid industrialization.
The China stimulus plan will also work as positives for underlying aluminum demand. Leading aluminum producers such as Alcoa and Aluminum Corporation of China, or Chalco (ACH) should also benefit from the improving demand outlook.
Copper is a major industrial metal with its price strongly depending on the economic growth outlook. The metal’s strong cyclical leverage accounts for its nickname “Dr. Copper.”
The metal’s popularity in industrial usage is due to its high ductility, malleability and thermal and electrical conductivity, along with its resistance to corrosion. In terms of consumption, copper holds the third place after iron and aluminum. Construction is the single largest market for copper, followed by electronics and electronic products, transportation, industrial machinery, and consumer and general products.
Copper prices witnessed record high levels from 2006 through most of 2008 as limited supplies, growing demand from China and other emerging economies led to the surge in copper prices and low level 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 based on the strong demand from emerging markets and limited supply. In 2011, London Metal Exchange (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.
In the first quarter of 2012, LME spot copper prices averaged $3.77 per pound. However, during the second quarter of 2012, LME spot copper prices averaged $3.57 per pound and dipped further to $3.50 in the third quarter. This drop reflected concerns regarding a slowdown in the Chinese economy, Europe’s sovereign debt crisis, and a slowing U.S. economy.
During fourth-quarter 2012, LME spot copper prices averaged $3.59 per pound. Overall in 2012, LME spot copper prices averaged $3.61 per pound, a 10% drop from 2011.
The drop in price has hurt the results of copper producers like Freeport-McMoRan Copper & Gold (FCX - Analyst Report) and Southern Copper (SCCO - Snapshot Report) and Newmont. Struggling with declining copper prices, Freeport has recently taken a major stride to venture into the U.S. energy space as part of the company’s strategy to diversify from its bread-and-butter copper mining business. The company is set to buy Plains Exploration & Production (PXP) and McMoRan Exploration (MMR) for roughly $9 billion.
Freeport’s copper business has been affected by the sluggish global economy. Demand from key end-markets, including construction materials and electronics, remains weak due to the overall economic softness. The buyouts are expected to provide new opportunities for the company.
Notwithstanding the current volatility in prices, we have a long-term bullish stance on copper, supported by its widespread use, limited supplies from existing mines and the absence of significant new development projects. Prices will be influenced by demand from China and emerging markets, 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. Companies that have a high leverage to copper prices will benefit immensely from the potential demand for the metal in the developing markets.
Overall Industry Outlook
Cost inflation in the sector is expected to be a headwind for metal and mining companies over the next several years, driven by a number of factors viz. labor, energy, ore grades, currencies, supply constraints and taxes. Global economic uncertainties, softening commodity prices, higher input costs are increasing the pressure on company margins.
To combat this, mining and metals companies are reviewing their portfolios to identify underperforming assets and shut down or divest these high cost and non-core assets. Industry consolidation, automation technology, owner-operated mines and investment in energy assets are some of the steps that companies are taking to mitigate the impact of rising costs.
Growth in the emerging markets, particularly China and India, was a major driver of metals demand over the last few years. However, of late, demand in China has slowed down. China’s recent $150 billion infrastructure stimulus has helped improve the sentiment somewhat and holds promise for the metals and mining industry going forward.
In the developed world, persistent recessionary conditions in Europe will have residual effects elsewhere. The U.S. Federal Reserve also appears to be actively engaged in sustaining the U.S economy’s momentum, which will hopefully jumpstart growth once again.
This synchronized global economic slowdown is the biggest headwind for the metals space overall at present. That said, the long-term picture remains a lot more promising as the emerging market economies are expected to get back in shape with the help of expected fiscal and monetary stimuli.