The sky is falling! The sky is falling! Buy, buy, buy.
I am looking at the doom and gloom in the marketplace and I think about how in some cases people overreact to bad news. I am going to stay away from the stupid pricing in mortgage bonds and focus on Vale, a.k.a. CVRD. Vale owns the iron ore business. It has the best reserves, the best quality, and a very long life of mine. If they decided to shut down production to Europe, they own enough of the market share to put Europe into a complete economic crash. They also have other assets that are not as nice. The price of nickel is way down as stockpiles grow and demand clearly weakens. Copper is not much better, and let’s not get into the aluminum demand. I am going to focus on the iron ore assets.
You have two forces at play here: The lack of capital is going to suspend lots of projects for the duration, and China has built up inventory because of the slowdown around the Olympics. Independent supply in the iron ore market is just not going to grow. Most of the producers that have production are not leveraged and therefore are going to be much more concerned about profit rather than revenue. China is going to milk its stockpiles as it finally has figured out that it alone was driving up the price of commodities. It has learned that if it takes 1% off of worldwide demand growth, it pays much lower prices for the stuff it wants to import.
So what is going to happen? In a nutshell, we are going to have railroad strikes and mines flooded, and Vale announcing a price rise and then saying it will not ship any product to China until it gets it. Production targets will get lax, maintenance will be done on equipment, and production will go down by 5-10% in the iron ore business. If this were nickel or platinum, global prices would crash, but as this is iron ore, the spot market price will crash, but do not expect the big three to be putting on any inventory reduction sales. The fact is running a mine at 95% of production vs. 102% will reduce operating costs significantly, and it is always much better to cut 7% of your production than 7% of your sale price.
What is going to happen is steel companies are going to get squeezed; the price of steel is going to come down; the price of ore is going to stay high; and we are going to have steel companies doing the dance of the stuck pig. Vale is not stupid. They have no need to ship ore. They can sit on their hands till the customer is begging them to ship. When they do not ship, it costs them $5-10 to idle the tonne of production–to idle a steel mill costs $70. Guess who wins in the waiting game? Vale, and the stuck pig will pay the price.
So what would I do in this market? My gut says buy Vale, as it is trading for the value of its iron ore assets, and the price does not assume any value for anything else. My gut says go short on the steel companies, especially the steel companies that do not have captive iron ore like ThyssenKrupp. There is going to be a consolidation in the junior iron ore marketplace, but the fact is the iron ore production business is going to stay strong because three companies own it and they will treat it well.
Going to be a fun year.
Benjamin
