Mr. Beristain: I'm the Head of Americas metals and mining equity research at Deutsche Bank. Historically, that encompassed coverage of both Latin American equity names and North American ones. Increasingly, I'm transferring primary coverage of Latin American names to our S-o Paulo-based team member, so my coverage is shifting to be more North American specific. But I come from a history of covering equities in Latin America. That has included mining companies like Vale, who is now the world's number two mining company by market capitalization, and other strong growth companies, like CSN (SID) and Gerdau (GGB) in steel, which now has a subsidiary, Gerdau Ameristeel (GNA), in the United States. So my current coverage is basically North American base metals producers - stocks such as Alcoa; Cliffs Natural Resources in the iron ore space; Freeport-McMoRan, the world's largest publicly traded company producing copper; Southern Copper (PCU), a top-five global copper producer. I also cover Thompson Creek (TC), which has exposure in molybdenum, part of the steel sector raw materials complex. And I maintain co-coverage of Vale.
TWST: Why do you like iron ore and coking coal as near-term plays? Which names are your top picks there?
Mr. Beristain: Within the metals complex there are three main types of commodities: traditional base metals, which are your LME-traded coppers, aluminums, ones that every day change in price; precious metals are the other big group, which include gold, silver, platinum and palladium, and also have a daily price; and then you have bulk commodities, which tend to trade more on a negotiated basis and historically there has not been a daily price-setting mechanism. By definition they are "bulky," so they are huge metals in terms of physical space required to transport them. In fact, bulk metals are now the largest commodity by volume that transacts in the world. Literally hundreds of millions of tons travel all over the world. The reason why we like bulk commodities is that it is historically a fairly small market in terms of the producers. You really can count three producers as being the global seaborne majors, and seaborne is a relevant market for iron ore. Roughly speaking, half of iron ore in the world travels over land or over lakes, as in the case of the Great Lakes region in the U.S. Over land, very much of it is integrated, and travels over land from Poland and Ukraine to Russia.
But what we're focused on is really the third-party market - that is, from the merchant sellers based in countries like Brazil and Australia that ship their ore by sea. And increasingly China is becoming the destination for almost all of that ore. The top three suppliers account for about 75% of this relevant seaborne market, and your largest end client is China, accounting for roughly 65% of the relevant end market for this commodity. So it's highly concentrated in terms of both sellers. Other relevant seaborne markets, like Europe and historically Japan, actually used to be the market five or six years ago before China's rise in terms of raw material needs. So what you're buying into by buying the seaborne iron ore-exposed companies is the trend in China of decreasing resource self-sufficiency. In other words, the faster China grows, the more it needs to turn to imports by its shortfall of domestic supply of commodities. And that's no different than, say, in energy. Obviously, we all know China is oil short. But it's increasingly becoming evident in a lot of other raw material commodities - in not only base metals, but particularly in the bulk metals, where they are being forced to go further and further afield. You'll hear of the Chinese increasingly backing startup projects in Africa and startup projects in riskier Latin American countries in order to at least partially ensure their raw material supply.
So the reason why we are near-term bullish on the bulks is that we were concerned about the possibility for a near-term pullback in a lot of the base metals because this was a sector that performed the strongest in 2009 - basically metals and mining stocks were the top-performing sector within the S&P in 2009. And so they've kind of already had their day in the sun. Conversely, the bulks were actually a slower metal to catch up. But really in about the fourth quarter, we started to see signs of life in that market, where there is a now a relevant iron ore spot price that allows us to track daily price movements. It's still for a thin amount of the volume - maybe 15%, 20% of bulk commodities now trade in the spot market. But it's indicative that the spot price right now is about 100% above the contract price. So that gives us a good feeling that, you know, if this annual negotiating period for bulk commodities comes up again - which should get wrapped up by the March-April time frame - we're kind of in the mating season, if you will. The big sellers, the big three sellers and actually China now has become the de facto global price setter. And at a time when the spot market is way ahead of the contract prices that were set last year - and these contract prices were set last year at a point of sort of maximum global depression, like last year when pricing was set in the summer - China did not look like it was going to need a lot of iron ore. And so prices for this commodity, particularly in the benchmark system - because prices are set once per year - fell 33% for iron ore for fines and 48% for iron ore pellets. That's why we expect a strong rebound in 2010 because the companies haven't had the ability, unlike the LME metals producers - copper, aluminum that reset on a daily basis - these benchmark guys need to wait like a whole year in order to reset their pricing up again. But they're effectively going to make up for lost time because now the pricing winds are really in their favor.
The exact same thing that I just mentioned for iron ore applies to coking coal as well - the pricing dynamic. You are seeing in that case metallurgical coal prices, or it's also known as coking coal, does reset on a more recurrent basis. It's set sort of all over the world in a different region roughly every three months. On a rolling basis, if prices were set most recently, say, in Asia, you can get a sense that when North America comes up to bat, which is the region that sets prices after Asia - and the Asians are setting higher prices quarter-on-quarter - that is also sort of a leading indicator for the upside in North American metallurgical coal prices. So in a nutshell, if you're sitting in a stock that could have a 30% to 35% price reset on its main commodities, particularly Vale, that are 80% exposed to iron ore - and in the case of Cliffs, they are 80% exposed to iron ore and 20% exposed to met coal - they're really sort of in the right place at the right time, and that's why we're bullish on those stocks.
Tickers included in this excerpt: AA, BHP, CLF, FCX, RIO.L, VALE
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