In an environment of declining steel prices, Geordie Mark, mining analyst with Haywood Securities in Vancouver, nonetheless believes that iron ore juniors are poised for a rebound. Read his reasons for optimism in this exclusive Gold Report interview.
The Gold Report: About 37% of the world’s population is in China and India, countries in the early stages of their use of steel and, thus, iron ore. You’ve said their infrastructure requirements should trend up “for a number of years, if not decades.” Yet, benchmark prices for steel are down 15% since March. Is this price weakness a short-term problem or is there cause for concern?
Geordie Mark: I think we are looking at a shorter-term issue related to a tightening in money supply in China, particularly affecting the smaller mills. These smaller mills need to moderate output or get injections of commodities at lower prices. But we are still looking at underlying demand growth to meet the needs of increasing industrialization in the advancing economies, particularly in China and India.
TGR: Even though iron ore stockpiles are within 3% or 4% of record levels?
GM: We believe that stockpiles in ports and so forth are higher largely because steel demand is higher, and there is a coincident increase in iron ore imports. Compared to last year, China’s year-to-date crude steel production is up ~12%. If we measure inventory in terms of a proportion of steel output, we see that this higher inventory level has formed a plateau over 2011.
The recent pricing downturn for iron ore appears to correlate to a short-term issue in money supply where steel mills are sitting on more expensive inventories. This pricing scenario has witnessed a rebound over the last week where renewed demand and restocking has been taking place in China at cost and freight prices of $130/ton (t). The relative drop in China’s inflation rate announced on Tuesday also provides us some solace for an increased potential fiscal loosening in China.
TGR: Some producers have shut down furnaces because of an excess amount of steel in the market.
GM: We usually see some seasonality at this time of year where demand tends to plateau, particularly in Europe, from August through the end of the year. However, we have witnessed some demand softening outside Asia, but we expect that this will pick up again at the beginning of the year with renewed orders.
TGR: Iron ore swaps, based on anticipated first quarter prices at the Chinese port of Tianjin, are trading at about $129/t. Clarkson Securities says iron ore swaps are showing no price rebound until about 2013. In June, you were forecasting average freight-on-board Brazil prices of 62% iron at $124/t in 2012. Has your forecast changed?
GM: We are forecasting $130/t for 2012, based on our assumptions of continued demand from China together with potential increases in export taxes on iron ore in India, which are expected to place limitations of exports from that country. We think that underlying demand, as well as moderation in metallurgical coal prices, will help move the price higher in the shorter term and marry with our expectations.
TGR: Infrastructure growth in North America is stagnant. Is this a drag on the share growth of North American junior iron ore miners, despite the continued steady demand in iron ore use in the BRIC countries (Brazil, Russia, India, China)?
GM: For the time being, across the equities, we see a move away from risk largely independent of commodity. The juniors, in particular, suffer in the interim, independent of where commodity prices are going. Iron ore juniors have obviously dropped recently, but we do expect prices to rebound when commodity prices recover and risk appetite returns to the market.
TGR: In your coverage sector, you have 12-month target prices on more than one iron ore junior that could see its share prices quadruple from current levels. What’s the thesis for rebounding prices in this sector?
GM: Our thesis is continued demand growth. The world’s two most populous nations still require fundamental components for continued industrialization and urbanization. Other economies witnessed comparable infrastructure growth paths over their infantile stages of industrialization, such as the U.S., Germany, Japan and South Korea. In comparison, China has not reached the levels that those countries did in the past, and India still has an appreciable way to go if it is to reach the zenith of infrastructure investment intensities of the other economies.
In future support of our thesis toward growth in steel demand and maintenance of elevated iron ore prices, we see that India’s concern over the future needs of its domestic steel sector has resulted in the government looking to impose even greater tariffs on iron ore exports. Such a move, together with lower iron ore prices, is expected to temper Indian exports and provide a mechanism to moderate seaborne iron ore prices going forward.
In addition, while we see growth in demand from China, partially aided by the country’s domestic program of low-income housing development, the market sees risk in the housing sector beyond that supported by government investment.
TGR: Let’s get to your coverage sector, beginning with Alderon Iron Ore Corp. (ADV:TSX; ALDFF:OTCQX). You have a Sector Outperform on the company with a 12-month target of $5.80/share. Alderon is trading below $3/share now. Please map out how Alderon’s share price could be catalyzed between now and the spring.
GM: Our valuation anticipates that Alderon’s project will move into production by 2015. Over the next year, the company is expected to achieve a number of key milestones that could move it toward our price expectations. Those milestones include the company increasing its underlying resource base at Kami, lowering project risk at the deposit by completing a feasibility study and bringing an offtake partner onboard.
Alderon has increased the depth of management expertise in the iron ore sector recently. The company is making the right moves to lower risk and bring on partners.
TGR: Who are some potential offtake partners?
GM: I think the usual suspects, particularly steel utilities out of Asia, such as China and South Korea. Utilities are looking for security of supply and for access to supply at cost, which obviously moderates their ability to supply steel and lower steel price environments. These steel utilities also want to become less reliant on the big three iron ore producers: Vale SA (VALE:NYSE), Rio Tinto (RIO:NYSE; RIO:ASX) and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK).
TGR: Would an offtake agreement inhibit a possible takeover?
GM: If structured in the right way, I don’t think so. Earlier this year, when Cliffs Natural Resources Inc. (CLF:NYSE) acquired Consolidated Thompson, the underlying offtake agreements that Consolidated Thompson had and its partnership with Wuhan Iron and Steel Corp. (WISCO) on a project and ownership basis didn’t limit the deal.
TGR: You are also bullish on Northland Resources Inc. (NAU:TSX), which plans to start mining iron ore in northern Sweden in late 2012. Most of the operations in Québec’s North Shore ship iron pellets, not concentrate. Do you have a preference as to what form the iron takes?
GM: I think the most important elements to consider here are what product captures the most value for a particular project and what is the proximity of the market that the company aims to sell into. An especially pertinent factor to consider for the iron ore sector is the generation of a project with the potential to feed into the market over the long term. On this basis, projects that can deliver higher iron content products—say 62% and above—are probably better positioned if they can moderate operating costs.
TGR: Your 12-month target on Northland is $6.80/share and it is currently trading at less than $1.50/share. That seems like a pretty bullish target. What are the catalysts?
GM: There is an overhang in the market related to the ongoing situation in Europe. Also, Northland must continue to finance project construction. The company is aiming to complete the raising of a syndicated $400 million in senior debt facility by the end of 2011.
We believe Northland’s Kaunisvaara project is on time and on budget for completion of construction by Q412. Completing the debt deal would be a significant catalyst because it removes significant uncertainty. Project completion in Q412, commencement of mining in Q412 and initial concentrate sales in Q113 are big catalysts for this company.
TGR: Northland recently worked out a deal to use Narvik as its port facility. Once the company starts shipping concentrate and seeing some cash flow, what will it do with that cash?
GM: We understand that Northland will re-inject its cash back into the company to facilitate organic output growth. It will look to increase output at Kaunisvaara, and then potentially develop the Hannukainen iron-copper-gold deposit just over the border in Finland.
TGR: Do you expect to see significant byproducts from the gold and the copper in that deposit?
GM: Northland’s predominant revenue generator is iron, but, certainly, copper from Hannukainen is likely to be a significant component. In the end, Northland is an iron ore company.
TGR: Once it achieves production, Northland will become the second-largest iron ore producer in Northern Europe. If an up-and-coming junior iron ore company can become the second-largest iron company overnight, that speaks volumes about how much room there is in this market.
GM: That is correct. In part, it has to do with Northland’s proximity to available infrastructure and the location of its deposits, which geologically reside within the same family of deposits that LKAB, Northern Europe’s largest iron ore producer, is exploiting today. It will be a big step for Northland to get into that 5 million ton (Mt) capacity.
TGR: Champion Minerals Inc. (CHM:TSX) has iron ore projects in the Labrador Trough. Your 12-month target there is $4.20/share, and it is trading at less than $1.40/share. Its Fire Lake North, Bellechasse and Harvey-Tuttle properties have a combined Measured and Indicated (M&I) resource of 400 Mt, grading about 30% total iron. There’s another 1.82 billion tons (Bt) at about 25.4% total iron. How does that resource compare with companies at similar stages of development, for example, Alderon?
GM: I think Champion compares directly with Alderon and Consolidated Thompson in terms of having ample resource size to consider a potential production path. Consolidated Thompson’s Bloom Lake resources had similar grade, but with more than 2 gigatons (Gt) of defined and compliant iron ore resources in its portfolio in the Fermont mining district, highlighted by more than 1 Gt on its flagship Fire Lake project, Champion is well positioned to use its resource portfolio to go into and expand on production.
TGR: What’s the likelihood that Champion will get its M&I resource above 1 Gt at around 30% iron within a calendar year?
GM: I think Champion has a good likelihood of graduating its resources into the M&I category. We expect to see a number of resource updates across the portfolio coming up. I would expect an updated preliminary economic assessment on Fire Lake North later in November.
TGR: Is 30.6% total iron a low grade for this sort of deposit? Is that a concern?
GM: It is similar to that exploited by Consolidated Thompson at the Bloom Lake mine. Many other features play a significant part if the underlying economics of a deposit (e.g., mass recovery and grind size). For instance, a measure of effective mass recovery is very important for iron ore resources as it can give you a gauge of the mass needed to be mined and processed to produce a certain amount of product of a particular quality. Mass recovery can vary significantly between deposits with similar iron content, so the figure plays an important role in evaluating the potential of an iron ore resource. You need to look at more than iron content to judge resource exploitation potential.
TGR: Do you cover any other iron ore stories our readers ought to know about?
GM: Talon Metals Corp. (TLO:TSX) is one that we have been keeping our eye on. It is included in our Junior X-Report. In late 2010, the company acquired a couple of iron ore exploration plays in Brazil, basically on the doorstep of Vale’s Carajás iron ore mine. Talon rapidly developed those projects and within a year moved it up to more than 1 Gt of defined iron ore resource.
We see a lot of catalysts going forward on Talon’s fairly rapid resource expansion and metallurgical definition programs. More resource expansion is likely to be announced via the publication of a number of resource updates over the next six months, and a preliminary economic assessment is expected to be completed in mid-2012. The company has now defined new resources of outcropping iron ore that look as though they have size potential in a region that is being actively mined for iron ore.
TGR: If investors want to add only one iron ore junior to their portfolio, how should they choose among the companies you’ve named?
GM: It all relates to their comfort with risk and geography, and whether they like to look at junior companies with resource expansion and development potential, or iron ore producers with output growth on the horizon. If investors are looking for resource expansion, Talon, Champion or Alderon deliver resource expansion and development potential. If they are looking for projects further along the development pipeline, New Millennium Iron Corp. (NML:TSX.V) and Northland are on the development path with their respective projects in Canada and Sweden. If they are looking for exposure to Canadian iron ore production, there is Labrador Iron Mines Holdings Ltd. (LIM:TSX) or Cliffs Natural Resources Inc. It just depends on where your risk comfort lies.
TGR: Geordie, thanks for your time and insights.
Dr. Geordie Mark, a research analyst with Haywood Securities, focuses principally on iron ore, coal and uranium companies involved in exploration, development and production. He joined Haywood Securities from the junior exploration sector, where he served in an executive role concentrating on exploration across Canada. Immediately prior to joining the exploration industry full-time, Dr. Mark lectured in economic geology in Australia and served as an industry consultant. He completed his doctorate in geology in 1998 at James Cook University’s Economic Geology Research Unit in Australia, specializing in aqueous geochemistry and igneous petrology applied to ore-forming systems.
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