DETROIT (ResourceInvestor.com) -- Today’s Wall Street Journal has a story entitled “Rio Tinto to Lift Ore Prices,” and it points out that the reason Rio Tinto [NYSE:RTP] is lifting ore prices is twofold: it is trying to increase its share price to where a takeover bid by (hostile) competitor BHP Billiton [NYSE:BHP] is prohibitively expensive, and it is raising ore prices because it can. In either case the most affected parties by this strategy are less the world’s iron ore miners than its steel makers, who will see a rise in the price, a minimum of 10% of their iron ore, by 75%, yes 75%!, if the miners get their way - and they usually do in the 21st century where virtual cartels operate freely outside of the U.S. and Europe.
In an age where China makes five times as much steel as the U.S., and, unlike the U.S., has essentially no domestic iron ore, the producers of iron ore have become huge and hugely profitable, and the enormous demand for steel within the BRIC nations has lengthened out the boom and bust cycle of steel making and iron ore supplying to where Wall Street youth’s are saying that the advent of a (another) new economy has ended this cycle forever. Yah, Yah. But in the meantime....
Even though America imports today only 30% of its iron ore needs, clearly the American steel making community should have a long-term strategic plan in the current environment of ever increasing iron ore prices, so here are some thoughts for them.
A Simple Iron Ore Supply Approach
There have been recent announcements, by a number of raw material producing countries, regarding the imposition of export taxes or limitations on the amounts of raw materials they will allow to be exported. What may be the most puzzling approach though is the position taken by China. On one hand, the Chinese are doing all they can to limit the export of those raw materials where they control the supply, such as rare earths, or have significant impact on supply, such as tungsten, antimony and indium; while complaining, at the same time, that other countries, such as India, are now looking at their own approaches to limiting the export of critical raw materials. The Chinese have gone so far as to object to the proposed strategy of some of the major iron ore producers, such as Rio Tinto, cited above, of selling more ore on the spot market, instead of on long-term or annual contracts.
This approach reminds me of the large, or previously-large, U.S. auto makers, who have engaged in long-term contracts for materials, only to threaten and coerce the dedicated suppliers into lower prices with “market tests” of their business when market prices fell, but to hold the suppliers to the contracts, even when it caused the suppliers to sustain often mortal losses, when market prices rose. While this seems to be the ideal short-term approach, you might ask Toyota or Honda about this strategy’s long-term impact on the business of the previously-dominant U.S. auto producers.
With the Chinese sitting on a mountain of rapidly-devaluing U.S. Foreign Exchange, wouldn’t it be a double win if these U.S. dollars could be turned into the very assets that the Chinese need to sustain their growth in a non-devalued form. This would suggest that the Chinese should be looking at raw material investments in the U.S., not just in the rest of the world. In the U.S. the “dollar is still the dollar,” and with the current slowdown in business, courtesy of the “marginal mortgage and banking scare,” some great values abound. A compounding issue, to anyone holding U.S. dollars outside the U.S., is how will the U.S. likely react to try to address the issue of the slowing economy going into a recession? Historically, this has been through the reduction of interest rates, which would likely lead to a further devaluation of the U.S. dollar.
A second consideration that I might point out to a Chinese investor is that while China may continue to impose export restrictions on strategic commodities, along with a number of other developing countries, the likelihood of the U.S. doing this is relatively small. The U.S., being the largest market in recent times, has focused on limiting imports, through the tariff structure. It is really not the mindset of U.S. regulators to try to restrict commerce, especially exports, via such means. Besides, even if they ever figure this out, there are ways to make an export-oriented project in the U.S. appear as a domestic sale and circumvent any such regulations.
A third consideration is that since the U.S. is a leader in the development of new technologies I don’t think most of the U.S. regulators have even considered the idea that raw materials can be used as ‘bait’ or a weapon to force production based on those new technologies to locate in the raw-material producing countries, to assure access to needed production inputs.
A recent spat in the press seems to be concerned about iron ore. Not only are the Indians threatening to use export controls and taxes to increase the cost of iron ore exported, presumably to China, but the triumvirate of major producers, Vale [NYSE:RIO], BHP Billiton and Rio Tinto, seem to have the Chinese by what we referred to when I was a kid as the ‘short hairs’, when it comes to pricing.
Why not then, if you are an iron ore customer, take some of your devaluing U.S. dollar ‘stash’ and buy up U.S.-based iron ore production. To minimize the risk of U.S. government intervention, as was experienced with the Chevron situation, look at new properties just coming into production or which would be easy to bring into production. You would likely have to concentrate on ‘mining-friendly’ U.S. states, especially if the speed at which you wanted to bring the production on was important.
For the identification of a mining-friendly U.S. locale, I went to the 2006-2007 Fraser Institute study. Two U.S. states are listed in the top 10; Nevada and Utah. I would initially look at mining properties in those states as potential investment targets, especially if speed-to-market is a major consideration.
The main problem here is there are only a couple of iron ore projects that I have been able to identify in these areas: the Palladon Ventures [TSX-V:PLL] and the little-known Titan Mining Group LLC, that I wrote about in my November 29, 2007, article, “Investing in Minor Metals I: How and Why to Invest in Rare Earth Metals II.” At that time I cited this privately held, or closely-held company as the “most interesting speculative play of all” if it ever came to market.
Palladon is in a 50% JV with Luxor Capital Partners, LLC, in the Iron Mountain (Utah) Property. In April of last year it was announced that China’s Shagang Steel was doing the due diligence to possibly buy the Luxor position. Also, Palladon announced on June 21, 2007, that they had entered into a 5-year agreement with Holcim to supply iron ore for use in the cement industry. As such, this opportunity may be somewhat tied up.
Titan Mining Group LLC calls their (Utah) claim the TIRE Property; Great Western Minerals [TSX-V:GWG], which is involved in the property with a 25% share in the rare earth content only, refers to it as ‘deep sands’. This is a bit more descriptive of the nature of the property, since it is a magnetite iron sands type deposit. As such it should be relatively quick and easy to put into production for iron ore, since blasting or other hard rock techniques should not be necessary.
When I talked to the company, I was told that they were basically looking at “scooping-screening-magnetic separation” allowing the gangue to be returned to the hole from which it came, or close to it. If this is the case, it could be a relatively low-cost recovery process with minimal environmental damage. Since this is a huge property (66 square miles), containing an estimated 1.5 billion tonnes of recoverable magnetite (based on early estimates), it would be capable of producing major quantities of iron ore on an ongoing basis.
A question still exists as to how this deposit could help the Chinese need and demand for iron ore since it is in Utah, and transportation costs to China would be very high. For this I would recommend they take a page from the scrap industry’s playbook, and look at the concept of ‘location swaps’. Since transportation costs are significant to the value of scrap, dealers got together and created identifying terms for specific types of ferrous and non-ferrous scrap – words like ‘honey’, ‘birch and cliff’, ‘dream’ etc. The only two factors that concern scrap dealers are ‘weight and grade’. Each of these trade terms stipulated the identity of a specific type of scrap, much like deliverable copper cathode to the London Metal Exchange.
By knowing exactly what they were dealing with, the dealers could establish a value for the material. This then allowed them to sell the scrap they had, or to swap what they had for what they needed. In the case of the latter instance, it also pertained to ‘place utility’. It allowed them to swap excess material they had in one place, for material they needed and another dealer had in another place. This swapping of material in different places, whether it was the same material or different types of scrap, became known as doing a location swap. You gave up material you had in location ‘A’ to a dealer who needed it there, for scrap he had in a location you needed it in; thereby saving the cost of physically moving both materials to where the specific dealers needed them.
It would appear that this could easily be done with material from either of the Utah properties. Both are near enough rail transport facilities to allow rail transport. Today, thousands of unit trains of coal move from the Colorado Basin, through Chicago, to power plants and industry in the East. With the concept and infrastructure already in place, how hard would it be to ship a few unit trains of iron ore from Utah to the Chicago-Cleveland area? Also, there would not have to be any transloading; the cars loaded at the mine or pelletizer could be channelled directly to the steel mills in Gary, Loraine and Pittsburgh, saving time and handling. If someone were to take advantage of the burn-off gas produced at the five oil refineries in the Salt Lake City area, possibly you could even add mini-mill sites like Crawfordsville (Nucor [NYSE:NUE]) and Indianapolis (Steel Dynamics, Inc. [Nasdaq:STLD]), for direct reduced iron (DRI) to the list along with the previously named blast furnace locations.
Who could this appeal to? Actually, anyone who is short their own production of iron ore and has to buy it on the open market in one part of the world while producing it in another. Companies like Arcelor-Mittal [NYSE:MT], which needs up to 40% market ore to meet its U.S. needs, might be able to replace the U.S. ore with Indian or Australian ore, which could then be delivered to the Chinese or other owner(s) of the properties. Could SeverStal [RTC:CHMF] ship ore from Russian facilities to China to replace the ore that the (Chinese?) producers in Nevada or Utah would ship to the SeverStal Rouge Plant near Detroit? Both of these situations might result not only in gaining a steady supply of iron ore, but in substantial savings in transportation costs. The reduced transportation requirements would even have a positive environmental impact, requiring less fossil fuels and reduced emissions from transport vehicles.
Now it is probably more complex than this. The old saying; “the devil is in the details” often rings true, but the idea in general would appear to have merit. Is anybody out there in Brazil, Russia, India or China listening? Are any American financial institutions ready to propose this type of deal to American or Chinese steel makers?
I think that iron has become far more precious than gold, and it is a good investment today.
