Metals and Mining Stock Outlook


"Lingering economic concerns, higher inflation expectations in many countries and the relentless Eurozone debt crisis will continue to drive gold prices this year."

The metals and mining industry encompasses the extraction (mining) as well as primary and secondary processing of metals and minerals. The industry is oligarchic in structure, with a few producers accounting for a lion's share of the output.

Iron and steel commands a major chunk of the global metals market—more than half the metals industry in terms of volume, 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 consists of companies engaged in the extraction and primary processing of gold, silver, platinum, diamond, semi-precious stones, uranium and other rare minerals and ores, along with the cultivation of pearls.

The industry is highly cyclical and competitive. Historically, it has suffered from overcapacity (excess of supply over demand). Metal producers are subject to cyclical fluctuations in prices, general economic conditions and end-user markets. The weakening outlook for global economic growth has emerged as a major headwind for the global metal industry. These near-term challenges aside, the group's long-term dynamics appear attractive.

A Detailed Look into Metals: Performance and Outlook


As the major stakeholder in the metals market, the steel industry was severely hurt by the global economic downturn. Recovery, however, was swift and forceful. According to the World Steel Association, world crude steel production was a record 1,527 Mt in 2011, a 6.8% annual jump. In the first quarter of the current fiscal, world crude steel production was 377.3 Mt, and improved further to 388.4 Mt in the second quarter. Moreover, recent data shows that crude steel production for July and August was at 252.5 Mt, trending 0.4% higher than the comparable period last year.

China retained its leadership position among the steel producing countries, yielding almost half of the global output at 48%, growing 2% year over year so far in the third quarter. Japan, the second largest producer, posted a 2% increase. The United States held the third position, producing 14.8 Mt of crude steel, flat annually and constituted 6% of the total global output. Asia improved 2.3% to 166.8 Mt, while production in Europe was a dampener, declining 4.5%.

The automotive and construction markets have historically been the largest consumers of steel. The automotive sector has shown significant promise. Auto sales in the U.S. surged 13% to 1.19 million vehicles for the month of September 2012. The seasonally adjusted annual rate (SAAR) went up 13.7% to 14.9 million vehicles from September last year, the highest sales rate in the last four years.

Auto sales for the first nine months of 2012 averaged 14.5 million SAAR and grew a promising 15%. 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, rebound in consumer confidence, thanks to a growing belief that the housing market is recovering.

The construction sector had been a drag on the steel companies' earnings. However, recent figures suggest a turnaround in the non-residential as well as residential construction sector. According to the American Institute of Architects, the architecture billings index (ABI), an economic indicator that provides an approximate nine- to twelve-month glimpse into the future of non-residential construction spending activity, stood at 48.7, up considerably from 45.9 registered in June.

Even though in the negative territory (since any score above 50 indicates an increase in billings), the index level pointed toward a moderation in the downturn. The momentum picked up in August with ABI climbing back into the positive territory with a score of 50.2 for the first time in five months.

The American Institute of Architects projects a 4.4% increase in spending this year for non-residential construction projects, on the back of increase in demand for industrial facilities so far this year along with sustained demand for hotels and retail projects. The spending is expected to accelerate further to 6.2% in 2013.

As per the U.S. Department of Commerce, housing starts increased 29% to a seasonally adjusted annual rate of 750,000 in August 2012 compared with August 2011. Building permits in August were at a seasonally adjusted annual rate of 803,000, 24.5% higher than the year-ago figure. It is worth mentioning that building permits in July this year had touched the highest level in four years at 811,000.

In a nutshell, record-low mortgage rates, rising rents and reduced prices of properties are luring buyers. These figures provide a glimmer of hope that U.S. residential construction is finally stabilizing and is on the road to a much awaited recovery.

Reflecting on the second quarter results of the steel companies in our coverage – ArcelorMittal, United States Steel Corp., Nucor Corporation and AK Steel Holding Corporation—we see revenues were constrained due to drop in average steel prices. This does not come as a surprise, however, as oversupply in the U.S. steel industry and increased steel imports in the domestic market affected steel prices, hurting margins and profits of steel players in the process.

Looking forward to the third quarter, the steelmakers expect profits to be lower than the second quarter due to continued increase in steel imports, decline in average realized prices along with macroeconomic uncertainty and sluggish growth in emerging markets.

For 2012, the World Steel Association provides a muted outlook, projecting a 3.6% increase in global steel usage, a sharp deceleration from 5.6% growth in 2011. This reflects a continuing slowdown in Chinese steel demand and Eurozone debt crisis uncertainties. Furthermore, questions about the U.S. growth outlook also loom large.

After recording a 6.2% growth in 2011, China's steel usage in 2012 is estimated to grow 4% to 648.8 Mt as the economy is entering a less steel-intensive growth phase as a result of the government's efforts to rebalance the economy and restrain the real estate bubble. After a weak performance in 2011, India is expected to grow by 6.9% to 72.5 Mt. Japan's steel usage is expected to drop 0.6% to 63.7 Mt in 2012, due to the impact of exchange rate appreciation despite the reconstruction activities after the March 2011 earthquake.

In 2013, world steel demand is expected to increase 4.5% to approximately 1,486 Mt. China's steel usage is expected to grow 4% to 674.8 Mt from the 2012 projections. India is expected to pick up pace and grow 9.4%, triggered by urbanization and surging infrastructure investment. In 2013, the steel use in the U.S. is envisioned at 99.5 Mt, recording 5.6% growth. Brazil is expected to grow 6.7% to reach 52.5 Mt in 2013. Japan is expected to decline further by 2.2% to 62.3 Mt, comprising 77% of the 2007 level. Europe is, however, expected to record a modest recovery of 3.3% to 155.8 Mt in 2013.

Given the scenario in Europe, ArcelorMittal, the world's largest steelmaker in terms of volume and Europe's largest steelmaker, had earlier decided to idle five of its 25 blast furnaces in Europe and announced the extended idling of a number of facilities. The company will continue to align its steel growth projects to match demand situations. To reduce its exposure to Europe, the company recently sold its 24% share in European energy company, Enovos International.

Steelmakers are increasing their consolidation efforts, particularly in China and India, in order 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 world's sixth-largest steel maker Nippon Steel Corporation with 27th-ranked 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 is set to replace China's Hebei Group in the second position, which has a production of 44.4 million tons. The merger is targeted to generate savings in the face of increasingly intense global competition.

To sum up, despite plagued by overcapacity and softening prices, the outlook for the sector is not that bad. The outlook for key end-markets in the automotive, transportation, energy, industrial and agricultural sectors remains favorable. The faltering construction sector is showing signs of a turnaround.

China's recent attempt to bolster its economy by approving 60 infrastructure projects worth more than $150 billion will help lift up 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 also benefit from the Federal Reserve's move to boost the U.S economy. However, the European debt crisis and its potential global impact remain an overhang on the industry.


As per the World Gold Council, 2011 was a milestone year for gold as global demand for the yellow metal grew 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 propelled by the investment sector, particularly in India, China and Europe.

In the second quarter of fiscal 2012, gold demand was at 990 tons, down 7% year over year. Increase in demand from central banks was offset by declines in demand for jewelry, investment and in the technology sectors, due to higher prices. Central banks continued to be the primary purchasers of gold, accounting for around 16% of total gold demand, at 157.5 tons. This was a record quarter for central bank, buying more than twice the purchases in the second quarter last year.

In absolute terms, gold demand in the quarter was valued at $51.2 billion, a 1% decline from the second quarter of fiscal 2011. Average gold price in the first quarter stood at $1,609.49, 7% above the prior fiscal's quarter.

Investment demand declined 23% to 302 tons, due to lower demand for ETFs and physical bars, particularly in India and China. Gold demand in the technology sector was 1,112.2 tons, a 5% decline year-over-year due to higher gold prices, weak consumer demand, uncertainty in Europe and substitution to more affordable alternatives.

Jewelry demand dipped 15% to 418.3 tons due to higher price levels. Jewelry demand in India, a major consumer of gold, was down 30%, mainly due to a deprecation in the Indian rupee against the US dollar, which led to record high local prices. Furthermore, slowing GDP growth, domestic inflation, high interest rates and below average monsoon rain also contributed to the decline. Gold in India is currently at an all-time high in rupee terms.

In China, another major market, demand for gold decreased 9% to 93.8 tons as consumers were discouraged by the slowing GDP growth and the lack of clear trend in gold price. However, China is expected to resume its pace as economic growth is expected to pick up as a result of the monetary easing implemented in the second quarter.

Mine production inched up 3 tons to 706.4 tons, up 3% year over year. Adverse weather conditions, interruptions at few operations and slower ramp up of production at few mines affected the production numbers during the quarter. Recycling activity decreased 12% to 363.7 tons, bringing the total supply to 1,059.1 tons, down 6% year over year.

Russia is becoming an important player in the global gold market. The Central Bank of Russia remains a significant purchaser of gold. A healthy domestic economy is driving the demand for gold jewelry in the region, catapulting it to the position of the world's fourth largest gold jewelry consumer. The region accounts for 8% of the total global gold output.

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 in 2011. The record gold price of $1,895 per ounce was attained in September, 33% higher than the 2010 peak of $1,421 per ounce recorded in November 2010. So far in 2012, gold has ranged from $1,540 per ounce to $1,791.75 per ounce, with an average of $1,656.18 per ounce.

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 the price of gold. Given the performance in 2011, and thus far in 2012, we expect this year to be stellar for gold.

This climb in gold prices has not translated into increased revenues at all of the gold miners. In the second quarter, while revenues at Kinross Gold Corporation and Agnico-Eagle Mines Ltd. benefited from higher average realized price of gold, Barrick Gold Corporation, Goldcorp Inc. and Newmont Mining Corp. could not capitalize from them due to increased cash costs. Moreover, Goldcorp was riddled with production issues at its Red Lake mine.

As prices for gold rise further, gold giants such as Barrick Gold and Goldcorp 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 and Kinross are slated to suffer from lower ore grades that subdue production levels, increase mining costs and negate the benefits of rising gold prices.

Ironically, rallying gold prices have 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 macro-economic factors. The value and wealth preservation attributes of gold continue to attract investors and consumers, and is considered a safe-haven investment. Concerns regarding economic growth in developed countries have made gold an attractive and safe investment option. The European sovereign debt crisis promoted gold as a currency hedge for European investors.

Lingering economic concerns, higher inflation expectations in many countries, including India and China, and the relentless Euro-zone debt crisis will continue to drive gold prices this year, as well. India, which alone consumes nearly 45%−50% of the world's gold, should drive demand for gold along with China. China will likely emerge as the largest gold market in the world in 2012 and Chinese gold demand is expected to double in 10 years.


The aluminum industry is highly cyclical, with prices subject to worldwide supply and demand.

Alcoa, Inc. the world leader in the production of primary aluminum, kicked off the third quarter earnings season with a revenue decline of 9% due to a 17% and 20% year-over-year decline in the realized metal price and realized alumina price, respectively. On an adjusted basis, the company reported earnings per share of 3 cents compared with 6 cents per share earned in the second quarter.

Results were down sequentially due to lower metal prices, seasonal factors and weakness in Europe. Alcoa's results in the past two quarters have suffered because of the decline in realized aluminum prices.

The company has trimmed its 2012 outlook expecting global aluminum demand to go up by 6% this year from the earlier expectation of 7%, due to the slowdown in China. Alcoa believes that the long-term prospects for aluminum remain bright and envisions that global demand for aluminum will double by 2020.

Alcoa's positive long-term outlook notwithstanding, prices have been under pressure, prompting companies to cut back on production. Rio Tinto plc plans to sell its aluminium assets and close its smelter in order to cut costs. In line with this, Rio recently sold its U.S.-based wire and cable business Alcan Cable for $185 million. BHP Billiton Limited is also mulling the sale of its aluminum and nickel operations to exit from its non-profitable projects.

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 is curtailing 390,000 metric tons of its system smelting capacity to improve its competitive position. Alcoa permanently closed its smelter at Alcoa, Tennessee, and two lines at Rockdale, Texas. Alcoa has completed partial curtailments at La Coruña and Avilés, Spain. The curtailment at its Portovesme, Italy smelter is underway.

This trend will 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 trending down 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 globally. 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 the recyclability and its 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 observed earlier this year is triggering a switch among manufacturers to aluminum. Automobiles, air conditioners and industrial components manufacturers are now shifting their focus on more economical metal. In response to the spurt 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 undergoing rapid industrialization.

The China stimulus plan and QE3 announcement will also work as positives for underlying aluminum demand. Leading aluminum producers such as Alcoa and Aluminum Corporation of China Limited, or Chalco should also benefit from the improving demand outlook.


Copper is a major industrial metal, with its price strongly correlated with the outlook for economic growth. The metal's strong cyclical leverage accounts for its nickname "Dr. Copper."

The metal's popularity in industrial usage reflects its high ductility, malleability and thermal and electrical conductivity, and 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 were at 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, thanks to 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 ranged from $3.39 per pound to $3.93 per pound, averaging $3.77.

However, during the second quarter of 2012, LME spot copper prices declined ranging from $3.29 per pound to $3.89 per pound, averaging $3.57 per pound. This drop reflected concerns regarding a slowdown in the Chinese economy, Europe's sovereign debt crisis, and a slowing U.S. economy. The drop in price has affected the results of copper producers like Freeport-McMoRan Copper & Gold Inc. and Southern Copper Corp. and Newmont.

Notwithstanding the current volatility in prices, we have a long-term bullish stance on copper. 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.

Despite the near-term challenges, the long-term outlook for the copper remains positive, supported by its widespread use, limited supplies from existing mines and the absence of significant new development projects. 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

Growth in 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 as the government cut its 2012 target growth rate to 7.5%, the lowest year-on-year growth projection in eight years. China's recent $150 billion infrastructure has helped improve sentiment and holds promise for the metals and mining industry.

In the developed world, persistent recessionary conditions in Europe will have residual effects elsewhere. The U.S. economy, which looked very promising earlier this year, no longer offers a robust picture. The U.S. Federal Reserve also appears to be actively engaged in sustaining the economy's momentum and its recent announcement of another round of quantitative easing, 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.

Zacks Investment Research

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