ABX Barrick Gold Corp. (BC) (delisted)

Overview

The Metals & Mining industry encompasses the extraction (mining) as well as the primary and secondary processing of metals and minerals such as aluminum, gold, precious metals, coal and steel. The industry is oligarchic in structure, with a few producers accounting for the lion's share of the output.

The largest segment of the global metals market is iron and steel followed by aluminum. The iron and steel segment comprises more than half the industry in terms of volume. This 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, such as pipes, tubes, wire, spring, rolls and bars.

The precious metal and mineral 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.

Historically, the automotive and construction markets have been the largest consumers of metals, accounting for more than 50% of total demand. Other metal consumers include energy, electrical equipment, agricultural, domestic and commercial equipment and industrial machinery. Large automakers such as General Motors Company (GM), Ford Motor Co. (F), Toyota Motor Corp (TM) and Honda Motor Co. Ltd (HMC) are large consumers of metals, especially steel and aluminum.

Overall Outlook

The global metal industry is cyclical, highly competitive and has historically been characterized by overcapacity (excess of supply over-demand). Metal producers are subject to cyclical fluctuations in London Metal Exchange prices, general economic conditions and end-use markets. Individual company profitability depends on volume and operating efficiency. Large producers with huge resources are able to discover and develop new deposits, thereby boosting reserves, while the smaller ones devote their attention to fewer mines.

Mergers and acquisitions (M&A) have historically been a critically important growth strategy for mining companies. The year 2009 experienced a lull in M&A activity under the impact of the global economic downturn, with a deal value almost half that of 2008. The focus of M&A activity shifted from being a driver of growth to that of defense, as companies looked to safeguard their teetering balance sheets rather than seeking expansion.

In 2010, fairly unpredictable financial markets dictated metals prices, despite strong underlying fundamentals. In addition, several notable mining accidents have made mine safety a major factor for the industry and regulators. Despite the volatility, gold prices rose 400% over the past ten years and made a record run in 2010, increasing 26% and hitting a high of $1,432 an ounce.

The year 2011 has been unstable for metals so far, with double-digit gold sell-offs and rallies during the first quarter. However, investors remain cautiously optimistic regarding the sector. Many analysts predict metal prices will end the year with double-digit growth considering demand is still outstripping supply.

Unrest in the Middle East is also driving metal prices. On the down side, the end of the Fed's QE2 program and overall atmosphere of greater focus on fiscal restraint may limit significant gains.

In an industry plagued with rising energy and raw material costs, increasing productivity and reducing costs are the keys to success. Given the cyclical nature of the metals industry, low-volume, and high-cost producers need to generate sufficient cash or ensure a strong borrowing position during market peaks to survive the market troughs.

Continuing consolidation supports the sector's ability to influence the cost of inputs and companies can also obtain synergies and economies of scale through the operation of vertically integrated raw materials sources. Expansion in low-cost countries will ensure lower labor costs and also help tap their growth potential.

Geographically, the Asia-Pacific region -- in particular China and India -- is witnessing higher production and consumption of metals. Per capita consumption levels in both these countries are calibrating to U.S./European levels, which could, theoretically at least, double metal demand in the longer term. China is the world's largest consumer of metals and is expected to remain so.

Further, developed regions such as the US and Europe are showing signs of recovery, albeit at a moderate pace. Overall, we expect global metal demand to improve in the long term with the recovery of user industries.

Demand as well as production for industrial metals in Japan has been recently affected as factories have been shut in the aftermath of the country's earthquake and Tsunami. Japan is the biggest buyer of aluminum and the second largest buyer of copper ore. We, however, believe that metal demand will be boosted by the construction industry triggered by the country's reconstruction efforts.

Detailed Look into Metals

Steel

As the major shareholder (about 60%) of the metals market, the steel industry was severely bruised by the global economic downturn. However, according to the World Steel Association, world crude steel production in 2010 reached a record 1,414 million metric tons (mmt), an increase of 15% compared with 2009. All the major steel-producing countries and regions showed double-digit growth in 2010. In September 2011, the world crude steel production was 124 mmt, an increase of 9.7% from September 2010.

China's crude steel production in September 2011 was 56.7 mmt, up 16.5% from September 2010.

Elsewhere in Asia, Japan produced 8.9 mmt of crude steel in September 2011, down 3.8% year over year. South Korea's crude steel production in September 2011 was 5.5 mmt, up 17.7% from September 2010.

In the EU (European Union), Germany's crude steel production in September 2011 was 3.7 mmt, up 10.3% from September 2010. Italy produced 2.6 mmt of crude steel, up 11.5%. France produced 1.3 mmt of crude steel, up 4.2%.

Turkey produced 3.0 mmt of crude steel in September 2011, 16.9% higher than September 2010.

The US produced 7.2 mmt of crude steel in September 2011, up 8.9% from September 2010.

Brazilian crude steel production for September 2011 was 2.8 mmt, 3.8% higher than September 2010.

The World Steel Association provided its Short Range Outlook (SRO) for 2011 and 2012. World Steel forecasts that apparent steel use will increase by 6.5% to 1,398 mmt in 2011, following a growth rate of 15.1% in 2010. In 2012, it is forecast that world steel demand will grow further by 5.4%.

China's apparent steel use in 2011 is expected to increase by 7.5% to 643.2 mmt following an 8.5% growth rate in 2010. In 2012, steel demand is expected to maintain a 6.0% growth rate, which will bring China's apparent steel use to 681.6 mmt.

In 2011, India's steel use is forecast to grow by 4.3% to reach 67.7 mmt. In 2012, the growth rate is forecast to accelerate to 7.9%.

Apparent steel use in the US is forecast to rebound strongly by 11.6% in 2011. In 2012, steel use in the US is expected to grow by 5.2% to 93.8 mmt, bringing it back to 87% of the 2007 level. For NAFTA as a whole, apparent steel use will grow by 9.0% and 4.9% in 2011 and 2012 respectively.

In Central and South America, apparent steel use is forecast to grow by 4.7 % in 2011 to reach a historical high of 47.8 mmt. In 2012, the region's apparent steel use is forecast to grow by 9.8% to reach 52.4 mmt, almost 28% higher than the 2007 level.

European countries continued to show divergent recovery paths in 2011. While steel demand in Germany and Poland are expected to grow at impressive rates, steel demand in Spain, by contrast, is expected to record a sluggish 1.7% recovery.

Overall, apparent steel use in the EU is projected to increase by 7.0% in 2011 to 155.0 mmt. In 2012, the growth of steel demand is expected to stall in most of the European countries with the notable exception of Poland which is forecast to post an impressive 9.5% growth. Overall, apparent steel use in the EU is forecast to grow by 2.5% to around 158.9 mmt in 2012, bringing it back to only 80% of the 2007 peak.

Japan's steel use is expected to decline by 2.7% to 61.8 mmt in 2011 due mainly to the disruptions caused by the earthquake. In 2012 apparent steel use in Japan is forecast to show a growth of 0.8% to reach 62.3 mmt, 77% of the 2007 level.

In the Commonwealth of Independent States (CIS, consisting of Russia and 10 other former Soviet Union republics), apparent steel use is forecast to grow by a strong 14.4% in 2011 and then by 7.5% in 2012. These projections will bring the region's apparent steel use in 2012 to almost 60 mmt, a new high for the region.

Steel demand in Middle East-North Africa (MENA) region is expected to fall by 0.9% in 2011, mainly due to downward revisions from North African countries. However, boosted by high oil prices, steel use in the region is forecast to resume growth in 2012 at a rate of 8.7%. Given that the political situation in the region is far from settled, considerable uncertainties hold out a threat to the current forecasts for this region.

In the third quarter 2011, sales of ArcelorMittal (MT), the world's largest steel-producing company, increased 22.6% year over year to $24.2 billion from $19.7 billion in the year-ago quarter but decreased 3.6% sequentially from $25.1 billion. Sales were down sequentially primarily due to lower average steel selling prices (-1.7%) and lower volume of shipments (-4.9%). Total steel shipments in the third quarter of 2011 were 21.1 million metric tons compared with 20.5 million metric tons in the year-ago quarter.

Similarly, sales for U.S. Steel Corp. (X) improved 13% year over year to $5.1 billion from $4.5 billion, in line with the Zacks Consensus Estimate of $5.1 billion. Shipments totaled 5.5 million tons, and were down by 0.8% year over year.

Nucor Corporation (NUE) sales surged 27% year over year to $5.25 billion beating the Zacks Consensus Estimate of $4.86 billion. The growth was attributable to an increase of 24% in average price per ton and a rise of 3% in shipments (to 5.8 million tons) to outside customers. Steel mill shipments grew 9% to 4.2 million tons during the quarter.

Currently, Nucor has a Zacks #3 Rank (Hold) for the short-term (1 to 3 months) while U.S. Steel holds a Zacks #3 Rank (Hold). ArcelorMittal currently retains a Zacks Rank #5 Rank (Strong Sell). We maintain our Outperform recommendation in the long term for ArcelorMittal and U.S. Steel, while we maintain a long-term Neutral recommendation on Nucor.

Gold

As per the World Gold Council, gold prices rose for the tenth consecutive year in 2010, reflecting recovery in key sectors of demand and continued global economic uncertainty. In 2010, gold prices jumped 29%, reaching $1,405 per ounce as of the end of December.

During 2010, the price of gold rose to record levels on several occasions, trading as high as $1,432 per ounce. Gold's performance was strong and volatility remained low. The World Gold Council suggests that the increase was not only driven by inflationary forces but was also inflated as both the private and public sectors of India and China rushed into the gold market.

Gold demand went up 9% over 2009, showcasing a 10-year high of 3,912.2 tons, driven by the rise in jewelry demand, the revival of the Indian market and strong momentum in Chinese gold demand. Moreover, central banks became net purchasers of gold for the first time in 21 years, hiking the demand for the yellow metal.

Major demand came from India and China. India bought 746 tons, a 69% increase over 2009, and China bought 400 tons of gold jewelry. China bought 179.9 tons of gold in the form of bars and coin, a 70% increase over 2009.

Global gold demand in the second quarter of 2011 totaled 919.8 tons, down 17% from the remarkably strong levels of 1,107 tons in the second quarter of 2010. Gold demand in value terms grew by 5% year-on-year reaching $44.5 billion up from $42.6 billion in the second quarter of 2010. This is the second highest quarterly value on record, only fractionally below the $44.7 billion record that occurred in the fourth quarter in 2010.

The quarterly average gold price rose by 26%, reaching a record high of $1,506.13 (as per the London PM fix).

Second quarter 2011 global investment demand was 359.4 tons, 37% down year-on-year from 574.2 tons in the second quarter in 2010, which was the second highest quarter ever.

Demand for gold bars and coins totaled 307.7 tons during the second quarter of 2011, a gain of 9% over year-earlier levels of 282.6 tons. In value terms, bar and coin demand was worth $14.9 billion, an increase of 37% from $10.9 billion in the second quarter of 2010.

Jewelry demand in the second quarter of 2011 was 442.5 tons, 6% higher than the year-earlier levels of 416.7 tons. In value terms, this represented a 34% increase to $21.4 billion from $16.0 billion in the same quarter last year. India, China and Turkey together accounted for 59% of global jewelry demand at 260.1 tons in the second quarter of 2011 and registered a combined growth of 36.1 tons on year-earlier levels.

Gold supply was 1,058.7 tons in the second quarter of 2011, which was a 4% decline from 1,108.3 tons in the same period in 2010, as a result of an increase in net purchasing by central banks. Mine production rose by 7% to 708.8 tons from year-earlier levels of 659.4 tons in 2010.

Gold remains a coveted asset given its long-term supply and demand dynamics and influenced by macro-economic factors. Concerns regarding economic growth in developed countries made gold an attractive and safe investment option. The European sovereign debt crisis made European investors use gold as a currency hedge. Pressure on the US dollar against various currencies coupled with higher inflation expectations in many countries, including India and China, also pushed up gold prices.

The value and wealth preservation attributes of gold continue to attract investors and consumers. Jewelry and investment demand in non-Western markets continues to rebound while industrial demand has started to recover in response to an improvement in economic conditions. India, which alone consumes nearly 45-50% of the world gold production, should drive demand for gold along with China. Chinese gold demand is expected to double in 10 years. As China and India continue to grow
rapidly, their demand for gold will also rise in tandem.

Higher prices bode well for gold producers, which should benefit giants such as Barrick Gold Corporation (ABX), Agnico-Eagle (AEM) and Goldcorp Inc. (GG). However, gold producers like Newmont Mining Corporation (NEM) and Kinross Gold Corporation (KGC) suffer from lower ore grades that subdue production levels, increase mining costs and offset the benefits of rising gold prices.

Overall, the stock prices of gold producers are not expected to benefit much from this favorable commodity-price backdrop. This is reflected in our overall long-term neutral views on the stocks. As major economies continue to recover, investors' confidence will be restored to invest in stock markets, which could cause gold prices to fall. However this is not going to happen in the near future. We have a Zacks #2 Rank (Buy) on Barrick Gold, Goldcorp and Kinross Gold Corporation and a Zacks #3 Rank (Hold) on Agnico-Eagle and Newmont Mining.

Aluminum

The aluminum industry is highly cyclical, relating to prices subject to worldwide supply and demand forces along with other influences. The global economic downturn had a historic, negative impact on the aluminum industry, leading to an unprecedented decline in LME-based aluminum prices, weak end markets, fall in demand, increased global inventories, higher costs of borrowing and diminished credit availability. The economy has, however, recovered from the crisis of the economic downturn.

Alcoa Inc. (AA) is the world leader in the production and management of primary aluminum. In response to the global economic downturn, the company implemented a number of operational and financial actions to improve its cost structure and liquidity, including curtailing production, halting non-critical capital expenditures, accelerating new sourcing strategies for raw materials, divesting non-core assets, reducing global headcount, suspending its share repurchase program, reducing its quarterly common stock dividend and resorting to other liquidity enhancements.

In 2011, Alcoa plans to restart certain idled potlines at three smelters. These restarts are expected to increase Alcoa's aluminum production by 137 kmt during 2011 and by 200 kmt on an annual basis thereafter. Such measures are sure to meet anticipated growth in aluminum demand.

On September 15, 2011, Alcoa announced it will expand its Davenport, Iowa rolled products plant to meet rising demand from the automotive market. More and more automotive original equipment manufacturers (OEMs) are switching from steel to aluminum as they seek to increase the fuel efficiency, safety, durability and performance of the cars they produce.

The expansion will entail an investment of approximately $300 million. The growth project will create an additional 150 full time jobs in Davenport once completed, bringing total employment to more than 2,300 high-value jobs. In addition, during construction, an incremental 150 jobs will be created at the plant. The expansion is expected to be completed by the end of 2013.

Alcoa is expected to benefit from the improving outlook of aluminum and alumina prices. Alcoa continues to project that aluminum demand will grow 12% in 2011 versus 13% growth in 2010, well ahead of the 6.5% compound annual growth rate needed to double aluminum demand by 2020.

Increasing demand in China, where the company has raised its 2011 growth projection two-percentage points to 17%, will mostly offset declines in Europe and other regions. China and India are undergoing rapid industrialization.

Both these factors are positives for underlying aluminum demand. We expect aluminum demand to increase over the next three years, outstripping supply growth. As a result, the aluminum market is likely to see deficits for a prolonged period. This provides a backdrop supportive of high alumina and aluminum prices.

We are also optimistic about Alcoa's long-term growth projects in China, Australia, Jamaica, Suriname and Brazil. Demand from these countries is expected to increase its alumina and aluminum production capacity while lowering its operating costs. The company recently expanded its Alumar Refinery, north of Brazil, and doubled its annual capacity from 1.5 million tons to 3.6 million tons of alumina. Recently, Alcoa started production at its Aviles smelter in Spain under the Primary Metal segment. We expect such expansions to drive Alcoa's top line.

Alcoa reported adjusted earnings per share of 15 cents per share in the third quarter 2011, missing the Zacks Consensus Estimate of 22 cents per share. Adjusted earnings more than doubled from 6 cents per share reported in the year ago quarter, but were 46.4% lower from the sequential quarter earnings of 28 cents per share due to lower metal prices, seasonal factors and weakness in Europe.

Revenues for the quarter were up 21% year over year to $6.419 billion, and were down from $6.585 billion in the sequential quarter. Alcoa's end-markets demonstrated strong revenue growth, on a year-over-year basis whereas sequentially they experienced mixed market conditions. Revenue was lower for both alumina and aluminum, down 5% and 1%, respectively, driven by lower alumina shipments and lower realized pricing in both businesses.

In the end-markets, revenue increased in commercial transportation (6%) and aerospace (2%), while declines were seen in automotive (7%), industrial products (6%), building and construction (5%), and packaging (4%).

Since the sudden decline from the peak prices in mid-2008, aluminum prices have increased over the last 2 years. In 2010, global aluminum prices increased 13%. Alcoa increased its fiscal 2010 profit on the back of higher prices and continued strengthening in most end markets. Aluminum Corporation of China, or Chalco (ACH) swung back to profit in 2010 after posting a loss in 2009, attributable to increased global aluminum prices.

In the medium-to-long term, aluminum consumption will improve globally with improving automotive and packaging industries, one of the key consumer markets. Aluminum is widely used for packaging, beverage cans, food containers and foil products. The automobile market is also becoming increasingly aluminum intensive, benefiting from the recyclability and the light weight of the metal.

Further, the surge in copper price this year is pushing manufacturers to switch to aluminum. Automobiles, air conditioners and industrial components manufacturers for example, are now shifting toward aluminum, which is more economical.

We expect aluminum demand to increase in the long term, outstripping supply growth with the improving end-markets. China and India are undergoing rapid industrialization. Both these factors are positive for underlying aluminum demand. Leading aluminum producers such as Alcoa, Paramount Gold and Silver Corporation (PZG) and Aluminum Corporation of China should benefit from the improving demand outlook.

Currently, Alcoa holds a Zacks #5 Rank (Strong Sell) supported by our long-term Underperform recommendation, while Paramount Gold and Silver has a Zacks #3 Rank (Hold).

Copper

Copper prices have shown a rising trend since 2010 benefiting copper producers like Freeport-McMoRan Copper & Gold Inc. (FCX) and Southern Copper Corporation (SCCO). Although copper demand was down 10% year over year in 2009, global copper demand has since been witnessing growth.

The Chinese demand for copper was still robust and imports of the metal were rebounding, which was supported by steady construction and infrastructure activity in the country. The improvement in copper prices would be supported by limited supply and increased demand from China.

Even though copper prices are close to their all-time highs, the outlook for copper prices remains favorable. Not denying the volatility in prices that are bound to remain, we have a bullish stance on copper prices, in the long term. However, as discussed earlier, manufacturers might now resort to aluminum as a substitute.

Market conditions are expected to be positive for copper in the next couple of years due to higher consumption of the metal in the developing nations. The companies that have a high leverage to copper prices will benefit immensely from the potential demand for the metal in the developing markets.

We currently have a Zacks #3 Rank (Hold) and long-term Neutral recommendation on Freeport and a Zacks #5 Rank (Strong Sell) on Southern Copper.

 
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