Replies to post #674 on The Rising Influence of Rising Affluence

[DewDiligence]

The foundation I advise sold BBL a few weeks ago based on valuation. Now we're thinking of buying it back because the pricing trend for iron ore is stronger than we expected. FWIW

[DewDiligence]

CLF is up an astonishing 80% since early February. Here’s why.
(#msg-43960884 and #msg-45843807 are good background reads.)

http://www.thestreet.com/print/story/10715422.html

›Iron Ore Upheaval Reaches U.S.

by Scott Eden
03/31/10 - 05:35 PM EDT

NEW YORK (TheStreet) – Iron ore hasn't seen this much excitement since perhaps the dawn of the Iron Age (circa 1300 B.C.). [LOL—great lead paragraph.]

Though it had been brewing for more than a year, a sea change swept across the iron-ore trade when BHP Billiton (BHP) announced on Tuesday that it had struck agreements with a "substantial number" of steelmakers in Asia. Not only did the behemoth Australian mining concern hike its iron-ore price by 90% from 2009, it also, in combination with similar moves by Brazil's Vale (VALE), killed the benchmark pricing system that had structured the miner-steelmaker relationship for the last four decades.

The ramifications of the shift are just beginning to be felt, and they extend far beyond the Australian and Brazilian mining districts and the Chinese steel-mill zones that have come to define more than 70% of the world iron-ore business. From the assets of Cliffs Natural Resources (CLF) in the Minnesotan Iron Range, to start-up mining entrepreneurs with dreams of exploiting huge ore bodies in remotest Canada, to the corporate corridors in steel towns like Pittsburgh and West Chester, Ohio, the changes to the benchmark iron ore pricing system, a seemingly international phenomenon, will eventually have an impact in good old North America.

It all began about eight years ago, when China's breakneck growth fueled an unprecedented expansion of its homegrown steelmaking industry. Roads, bridges, buildings, factories: the need for steel grew so acute in China that demand for iron ore (steel's core ingredient) drove the world price of the raw material ever higher. By 2008, it had risen by some 375% over the previous several years.

The global recession did nothing to dampen China's growth or its hunger for steel. All kinds of records were set in 2009: tons of steel produced, tons of iron ore imported, tons of iron ore extracted, even as the benchmark price a year ago fell by about 48% from the 2008 peak.

With the price of the metal (chemical symbol Fe, atomic number 26, abundant in meteorites) shooting higher, the world's three biggest iron ore miners -- Vale, BHP and Rio Tinto (RTP), in descending order of size -- began to politic for a change to the benchmark pricing system, in place since the 1960s.

Under that system, at the beginning of each year, the big global miners would begin negotiating with their steelmaker customers in Japan, South Korea and China. The first pair to strike a deal set the annual "benchmark" for the seaborne iron-ore market (that is, the ore that's hauled over the oceans, which is the majority). Using that price, all other miners and steel companies would fall into line for the rest of the year.

BHP, especially, came to argue that the annual-contract status quo was unfair: Iron ore ought to trade like other commodities, BHP argued; it ought to have a robust spot market, where, traditionally, only about 10% of the world's iron ore was bought and sold. Steelmakers, for their part, wanted to maintain the stability of a yearly fixed price. The annual contract negotiations grew contentious: Some even blamed the heated talks on the still-unfolding drama surrounding China's arrest and conviction of four Rio Tinto iron-ore salesmen on bribery and commercial espionage charges.

And there was the added friction caused by the ineluctable global mining consolidation that had resulted in three companies controlling more than 70% of the iron-ore market. Steel trade groups raised their hackles, hinting at collusion. Says one stock analyst covering mining and metals in the U.S., "If I were a steel mill, I'd be screaming and running to any antitrust authority I could find."

But the miners had the advantage. In China, especially, with demand roaring despite the severe recession elsewhere, they needed their iron ore. In one key move away from the annual-contract pricing regime, the Singapore Stock Exchange last April began trading iron ore swap contracts -- the first time in history that the raw material changed hands on an exchange.

(The move toward a market governed by short-term pricing has been ineluctable, however: Last year, the big three and China's buyers never did come to an agreement, and China wound up doing all of its ore buying on the spot market.)

Now, with BHP and Vale claiming victory, everyone agrees that the old system is dead. There is no going back; you can't go home gain; the genie is out of the bottle. Choose your cliché.

Over the short term, industry observers and participants agree, the sea change will benefit the miners. And that includes more than just the big three in Australia and Brazil, where iron-ore grades are the best in the world.

Look no farther than the taconite iron ore fields of Minnesota and the Upper Peninsula of Michigan. That's where Cliffs Natural Resources, the only major independent iron-ore miner in North America, owns surface six mines that, via the Great Lakes, feed the old rust-belt steel mills from Gary, Indiana, to Cleveland.

Cliffs has long used a formula to strike long-term pricing arrangements with its customers. The supply contracts can sometimes cover as many as 12 years, though there is room for the price to fluctuate as supply and demand ebb and flow, and as steel prices themselves change over the short term.

The precise details of the formula are secret, but Cliffs is open about its three basic components: the going price of hot rolled band steel (a staple product with automotive uses), the costs of production (energy, fuel, and other commodities, part of which it gauges by using the producer price index), and the world price of seaborne iron ore -- as set, in the past, by the Vale-BHP-Rio benchmark.

For this reason, both Cliffs and its much smaller North American rival, the Iron Ore Co. of Canada (which is majority owned by Rio Tinto anyhow) will say publicly that they are "price followers" or "price takers," and that, as yet, they've taken no public stance on the huge changes now sweeping through the iron ore business.

"I don't think we have anything to say on that," said Christine Deutsche, a Cliffs spokesperson. "We're going to have to wait and see how this affects us. It's kind of too early to call."

Others aren't so circumspect. Michael Locker, a longtime steel industry consultant, believes that Cliffs too will soon shift to shorter-term pricing arrangements with its customers. "The days of the long-term contract are over, for everybody," he said. "Assuming they want to make more money, I could see Cliffs switching." Likely that would mean a built-in mechanism that somehow traces the fluctuation in spot prices.

More immediately, Cliffs will benefit from the 90% rise in the world price of iron ore that this week's BHP and Vale deals have indicated. The last time the benchmark popped by such a degree -- 86% in 2008 -- Cliffs was able to raise its prices by perhaps 25%, estimates Peter Kakela, an iron-ore industry expert at Michigan State University.

Some analysts believe Cliffs will now need to lift its earnings projections for the coming year. The company's earlier guidance had called for just a 40% increase in the 2010 seaborne benchmark price. Cliffs' shares have indeed rocketed higher this year as investors have betted on just this outcome (and a recovery in U.S. steel business in general). Since Feb. 8, the stock has gained 77%.

As for manufacturers of steel, the move to short-term iron ore pricing is either a boon or a major annoyance. Squarely in the former group are U.S. Steel (X) and ArcelorMittal (MT), both of which control their own iron-ore sources. They thus gain a global competitive advantage when rivals elsewhere, who don't own so-called "captive mines," must contend with rising ore prices. Inevitably these steelmakers must pass along the cost to their customers.‹

[DewDiligence]

Steel Prices Regress from Post-Recession Peak

[Steel prices largely determine iron-ore and met-coal prices, although there’s a time lag. The recent dip in steel prices after a sharp increase from the recession low is not unduly troubling, IMO, but it bears watching. It is undoubtedly one of the reasons such stocks as CLF have not performed well since April after a spectacular run during the previous year or so. #msg-47105334 and #msg-45365876 are good companion reads.]

http://online.wsj.com/article/SB10001424052748704699604575343323011738364.html

›JULY 6, 2010
By ROBERT GUY MATTHEWS

Steel prices in the U.S. are declining after holding firm for months, potentially a bad omen for the nation's economy as manufacturing activity slows and consumers grow more cautious about big-ticket purchases, such as cars and appliances.

Steel prices tumbled in June, and U.S. steel mills are responding by cutting production. Earlier this year they were ramping up capacity to meet the growth in demand they hoped would emerge from the economic recovery. Instead, demand has been spotty.

Another wild card for the industry is China. While the rest of the world was reducing steel production and consumption during the recession, China's voracious appetite for building bridges, autos and appliances, helped support global steel prices.

For the most part, China has stepped back from exporting raw steel, in favor of higher-value finished goods. But a recent easing in demand by China's domestic steel consumers has raised fears the country could step up steel exports to the U.S. and other markets.

"There is a very real risk of steel from China being dumped illegally into the U.S. market, despite all the recent trade action," said Michelle Applebaum, of Steel Market Intelligence, a steel consulting firm.

Over the past several years, the U.S. has been aggressive in filing trade cases and using trade laws to prevent China from dumping steel—or, exporting it at less than home-market prices. The U.S. has laws or quotas restricting several types of Chinese-made steel products, including hot-rolled steel, plate steel, pipes and tubes, but Ms. Applebaum said those measures aren't as effective as the ones used by Europe and Canada.

Amid the slump in U.S. steel prices, which is expected to persist at least through much of the summer, ArcelorMittal, the world's largest steelmaker, is planning production cuts at its Indiana mills.

Russia's Severstal, which operates several mills in the U.S., is expected to idle its blast furnace in Maryland this month due to slack demand. Severstal spokeswoman Elizabeth Kovach said the facility is being idled because of a slowdown in the construction-steel market.

Analysts don't expect demand to pick up anytime soon. That means steelmakers are likely to keep a tight rein on production for fear of sending prices even lower.

Further steel-price declines could be good news for big steel consumers, lowering costs for builders, heavy-equipment makers and others. But prices would have to stay low for a while to have a lasting impact, since most heavy steel users rely on annual or biannual contracts to lock in prices from their suppliers.

Other steel consumers order on an as-needed basis. "We are seeing some of our customers canceling orders for hot-rolled coils out of Houston,'' said Alex Marshall, a sales manager at Texas-based steel distributor A&M Steel Co.

"Customers are putting off orders thinking that they can pick up the same steel, but at a cheaper price, a couple weeks from now,'' he said.

U.S. steelmakers, expecting the economy to be stronger by now, restarted too much capacity earlier this year, a move that has come back to haunt them, said Charles Bradford, an analyst at New York-based consulting firm Affiliated Research Group LLC. Domestic steel prices for hot-rolled steel coil, used for a wide range of products, such as automobiles and appliances, fell 4.5% in June to about $630 a short ton.

Mr. Bradford said he thinks the price could fall an additional $80 a ton in coming weeks. He estimated that the price of hot-rolled coil could fall as low as $550 a ton.

Steel buyers don't think prices are likely to head back up until August at the earliest, when steel demand tends to increase as the seasonally slow summer draws to an end.

Mitchell Ryan, a middleman who buys hot-rolled coils to makes appliance parts, said his inventory is growing. "I stopped buying coils in late May," he said. "Right now, I am going to work through some inventory and buy more later because prices are going to continue to fall."

Up until recently, the U.S. steel market avoided the softening that began this spring in other parts of the world. That's because the U.S.'s ample domestic supplies of steel's raw materials, including iron ore and coal, and the high cost of ocean shipping keep the U.S. relatively isolated from the global market. Still, imported steel typically accounts for about 20% of the U.S.'s steel needs.

U.S. steel imports have increased slightly over the past few months, rising about 4% in May, as domestic output expanded and overall demand crept higher. In June, American steel mills were operating at about 72% of capacity, up from around 64% at the beginning of the year.

Steel prices outside the U.S. dropped 5.1% in June, exceeding the U.S. decline, according to MEPS International, a British steel consulting firm. Hot-rolled steel prices in China fell 2.4% in April and 3.6% in May, and are now around $590 a metric ton, about $40 a ton less than in the U.S.

The falling global price of steel is also affecting prices of other commodities. Spot prices for iron ore, one of the main ingredients used in steel production—have fallen by about 6% since May to about $138 a metric ton on the global market [this is still about double the price at the 2009 low], according to the Steel Index, a steel research firm.‹