Category Archives: Iron


Commodities: Stick To The Fundamentals, Beware Of Speculation

  • Oil prices are increasing the number of rigs, putting pressure on prices.
  • Soros sold his gold, should you?
  • Iron ore is hot, but waiting until winter might provide better purchasing opportunities.


Yesterday we discussed how Treasury Inflation-Protection Securities (or TIPS) are a great protection during times of inflation. Today we are going to take a deeper look into another great inflationary protection, commodities.

The general feeling is that commodities have surged since January, but there is a high level of divergence. This divergence in commodity price movements is due to speculation in some commodities and fundamental reasons in others.

Situation – Oil

Oil is currently trading at $46 per barrel which is 75% higher than it was at its low six months ago.

figure 1 oil prices
Figure 1: Oil prices. Source: Bloomberg.

The 75% price jump in oil is a clear indication of price speculation in oil markets because the demand is stable and well known. Speculators include the whole chain, from producers to retailers and future traders who can trade high quantities on margin. In such an environment, the only option is to make an educated guess about the long-term fundamental oil price and trade around it. As Russia and Saudi Arabia are in talks to stabilize the oil market, we could see the market push through year highs, but higher prices call for more global production. As oil prices stabilized above $40, the number of U.S. rigs increased for seven consecutive weeks and the global rig count also increased in July. More rigs mean more supply and further pressure on oil prices.

Investors should be careful with oil, production is very flexible and much of it is low cost which disables a higher level price stabilization. Therefore, oil is a pure trading play with fundamentals easily influenced by speculation.

Situation – Metals

As we discussed gold yesterday while discussing traditional safe haven assets, today we are going to focus on iron ore, copper, zinc and aluminum.

An additional warning for those long gold, George Soros, the legendary hedge fund manager that opened a $263 million position in Barrick Gold in Q1 has cashed out in Q2. Be careful not to get burned on gold as smart money is slowly leaving the playing field.

Iron Ore

Iron ore has had a wild ride this year, but its supply is much less flexible than oil and divergence from fundamentals can be easier to grasp.

figure 2 iron ore
Figure 2: Iron ore prices. Source: Bloomberg.

As iron ore is more predictable than oil, Morgan Stanley sees seasonal weakness ahead, increased supply due to the VALE S11D project, and suggests that prices might fall back to $40 again. Those dips are excellent opportunities to open a position in iron ore miners as when iron ore prices are low, their share prices also decline. By looking at the lowest cost producers, share price is the main risk factor as in the long run, big, low cost miners are unavoidable for global development. Companies to look at are Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE) and Glencore (GLNCY), but for lower risk it might be better to wait for winter.

Aluminum & Copper

Aluminum is only up 8% year-to-date, and copper is only up 3%. Both metals are a clear example of how commodities diverge. This divergence is what creates opportunity because lower prices tend to eliminate high cost production, limiting supply and pushing prices up again. The current price stability for aluminum and copper, and price increases for precious metals and iron, suggests that the 5-year commodity bear market has come to an end and things should slowly turn as we begin to run into supply deficits due to lower investments.

Aluminum and copper are closely related to global economic growth. An good aluminum play is Alcoa Inc. (AA), while with copper it’s good to look at the lowest cost producers.

figure 3 copper costs
Figure 3: Copper production costs. Source: Southern Copper Corporation (SCCO).

The production cost for the stock pick detailed in The Copper Goldmine—a report I wrote earlier this year, along with an update, that was sent to subscribers last Friday—was $0.92 per copper pound in Q2 2016, and is expected to be $0.52 for the company’s future copper project putting it among the lowest quintile in terms of production costs. To download this report, click here.


Zinc is the superstar metal of the year. It has increased by more than 50% year-to-date and is expected to increase more due to the inevitable supply gap forming. More about the zinc supply gap here.

In addition to our above mentioned stock pick—which is transitioning from a mostly copper producer to a mostly zinc producer in 2017,—another good option to be exposed to zinc, copper and aluminum is the PowerShares DB Base Metals Fund (DBB) with equal weights for zinc, copper and aluminum.


Commodities seem to have reached a bottom, but global economic turmoil or China slowing down might ignite speculators to short metals on margin and put severe downward pressure on prices. Therefore, any commodity related investment has to be done with the notion in mind that 50% of it can quickly be lost.

On the other hand, the world cannot live without commodities and therefore it’s a good idea to be exposed to such an investment, especially to miners as their prices increase exponentially if commodity prices increase due to their fixed costs. Production costs are always the main factor in assessing how much can be lost when investing in commodities.

A good strategy with commodities at this point in the commodity cycle is to average down if commodities experience further declines and then ride in full the eventual upside. The upside is certain as global demand for commodities is expected to grow as a result of increasing demand from developing countries.

To sum things up, commodities are at or near their bottom. The upside impetuses to be aware of are growing global demand, limited supply and potential inflation, while downside risks come from an eventual slowdown in China or a global recession.


Will A Bet On Commodities Pay Now?

  • Iron ore prices are falling as supply continues to grow, while copper and zinc prices show signs of supply gaps forming.
  • Low exploration and discoveries indicate that metals will be winners again in the future.
  • The possibility of future inflation increases the appeal of commodities.


Diversification is the ultimate protection against various economic factors, in recessions you might want to hold gold or treasuries, in inflationary times you want to be long stocks and commodities. Therefore it is very important to always know what is happening in each potential diversification sector.

Three weeks ago we discussed how aluminum is a bet on global transportation and while a supply gap is not the issue, productions costs are. In this article we are going to analyze what is currently going on with iron, copper and zinc. Before we analyze each individual metal, there is one very important trend in the mining sector which will affect all three metals, low prices which minimize exploration investments and new discoveries.

figure 1 discoveries
Figure 1: Expenditures and mineral discoveries. Source: Rio Tinto.


The low number of new discoveries means that sometime in the future there will be a new supply gap like the one we experienced in 2011. It is too early to call for such a situation now, but those are the future benefits of a well-diversified portfolio with commodities.


Let us start with the most mined metal in the world, iron. Iron prices have been declining since 2011 after hitting a 30-year high of nearly $200 per ton. Prices then bottomed out in December 2015 at $40 per ton, only to jump to $60 per ton in April 2016 and then slowly decline to the current price of $50 per ton. From an historical perspective, prices are still high, but it is important to analyze the current supply and demand situation in order to see if iron is a good diversification metal, especially as central banks target inflation.

figure 1 iron ore prices
Figure 2: Historical iron ore prices. Source: index mundi.


All the biggest iron ore producers recently came out with their Q2 2016 production reports, giving a clear indication of the trend in commodities. The results are mixed, Rio Tinto (NYSE: RIO) increased iron ore production by 10% year over year while BHP Billiton (NYSE: BHP) decreased production by 2% and Brazilian Vale (NYSE: VALE) decreased production by 1%. As all major producers are developing new mining projects—like Vale’s 90 million tons per year S11D—and are able to increase production if necessary, we cannot expect the formation of a supply gap in iron and a surge in prices similar to what we witnessed in 2011. Further, as major producers keep increasing production it will keep a lid on future prices.

In order to be diversified with iron, the best thing is to look at the lowest cost producers who are profitable at much lower prices.

figure 2 iron ore cost curve
Figure 3: Iron ore cost curve. Source: Metalytics.


The lowest cost producers manage to have positive cash flows even with iron ore prices below $40, which is still a possibility if we see more global turmoil or slowing in China. On the other hand, iron should be a relatively good hedge against inflation.


Copper has reached its seven year low in January 2016 with prices below $2 per pound, but the recovery has been much smaller than with iron. Current prices are at $2.20 and copper has been trading in the $2.05 to $2.25 range since March.

figure 4 copper prices
Figure 4: 10 year copper prices. Source: Nasdaq.


But copper is expected to enter a supply gap in the next few years as global copper grades are getting lower, big mines are being closed and demand is constantly growing.

figure 5 copper deficit
Figure 5: Expected copper supply gap. Source: Visual Capitalist.


A sign of how important copper is comes from the fact that both Rio Tinto and BHP Billiton base their strategic exploration on copper. In 2015, Rio Tinto spent 66% of its exploration budged on copper with 25 of 37 exploration targets being copper focused.

figure 6 rio tinto exploration
Figure 6: Rio Tinto’s exploration. Source: Rio Tinto.


A commodity that is already in a supply gap and is a great example of what can happen to copper, is zinc.


Similarly to the above described commodities, zinc has reached its multi-year low in January 2016 with prices below $0.7 per pound. But, unlike copper, prices have quickly rebounded to the current $1.03 and the trend looks very positive.

figure 7 zinc prices
Figure 7: One year zinc prices. Source: Infomine.


The reasons for such strong performance are an increase in Chinese infrastructure spending, mine closures and a global increase in demand. With current zinc usage a few percentage points higher than production, we should expect even higher prices.

figure 8 zinc supply
Figure 8: Zinc supply and usage. Source: International Lead and Zinc Study Group.


Investing Opportunities

The lowest risk commodity investments are big miners with low debt levels and low costs.

Another option is to invest through ETFs that hold metal futures. Such an ETF equally spread in aluminum, copper and zinc is the DB Base Metals Powershares. Higher returns can be achieved by investing directly into specialized miners with low debt and low costs, giving a greater assurance of a profitable investment, however the risks also increase. 


Knowing how metal markets work, that near term supply gaps exist for several metals, and that prices are still close to multi-year lows minimizes risk and makes metals an attractive investment opportunity. But the main point of this article is that commodity metals are a protection against inflation since the metal supply is not flexible in the short term and fewer and fewer profitable mining operations are being discovered. With global central banks keeping interest rates very low, and increasing money supply, sooner or later inflation will kick in. Until that happens and metal prices rise, you can enjoy the high dividends miners are currently paying and have a well-diversified portfolio.



Investment Opportunities in Iron Ore

  • Iron ore as a commodity faces long term oversupply.
  • The shift to a service oriented economy lowers Chinese steel demand growth.
  • Short term euphoria makes iron ore and related assets great for trading.


Iron ore is the world’s most mined and commonly used metal as 98% of it is used to make steel. As steel is mostly used for infrastructure and building it is not surprising that China is the world’s biggest consumer of iron. China produces 50% of the world’s steel output and 47% of the world’s iron ore.

Figure 1: Steel consumption in China and the world. Source: LKAB.

Therefore, China is the main factor for iron ore pricing. As Chinese demand for steel grew so did the price of iron ore. Increased iron ore prices brought increased investments in mining, and currently supply is higher than demand. In such a situation, a decline in prices is unavoidable and the decline in iron ore prices has been unstoppable for the last 5 years. From $180 per ton in 2011, the price of iron ore has eroded to the current price of around $60, but also reached prices below $40 in December 2015.

2 figure iron prices

Figure 2: Long term iron ore prices. Source: Iron Ore: Facts.

Unfortunately for iron ore miners, the outlook is not bright. The World Steel Association (WSA) is forecasting a decrease in steel demand in 2016 of 0.8% and just a slight increase of 0.4% in 2017. Also, unlike other commodities like copper, the world’s iron ore reserves seem enough for many more years of increased consumption. Estimated global reserves are 170 billion tons while current global consumption is 3.2 billion tons per year.

With low prices, high iron ore availability and lower demand for steel, logic would have miners lowering output in order to realign supply with demand to increase iron ore prices. But the world’s biggest miners have chosen a different way, one that has also strongly influenced the above price decline.

The Iron Ore Increased Supply Strategy

The strategy in the iron ore mining sector is one of increased supply in order to force high-cost supply to exit the market. The goal of such a strategy is to increase market share and reach higher profits with lower margins on bigger volumes. The world’s largest miners—Rio Tinto (NYSE: RIO), BHP Billiton (NYSE: BHP), Fortescue and Vale (NYSE: VALE)—are all increasing production. RIO and BHP require iron ore prices at around $25 to break even while Fortescue and VALE require prices to be around $40. 25% of global iron ore production has costs above the current spot price and most of the high cost producers are in China. Therefore, the big global miners hope to reach maximum profits by increasing production and completely conquering global markets.

3 figure cost curve

Figure 3: Iron ore cost curve. Source: Metalycs via

The strategy is not yet showing positive signs as all the above mentioned miners have reported losses (RIO and VALE) or minimal profits (BHP and Fortescue) in the last 4 quarters. In order to see if the strategy is going to pay off in the long term, it is necessary to look at the forecasts for iron ore.


In the short term iron ore prices have quickly recovered from this winter’s lows and are currently boosted by increased building expectations in China. But, Goldman Sachs is describing this increase in prices as temporary because there was no shift in raw-material fundamentals and expects iron ore prices to return to $35 per ton soon. Also, RIO and BHP have warned that prices will come down again.

A mid-term outlook shows that iron ore is bound to stay at low levels as the trade balance outlook remains highly positive through 2020.

4 figure trade balance

Figure 4: Iron ore China trade balance (price is from begin 2015 and has to be adjusted lower). Source: ABM Brasil.

The World Bank estimates that iron ore prices will be around $50 per ton for the next five years as the increase in low cost supply is much larger than the closures of high cost mines.

In the long term, iron ore prices are completely dependent on steel demand and steel demand is not expected to grow at the same rates it used to grow in the last 15 years.

5 figure steel demand forecast

Figure 5: Steel demand forecast. Source: ABM Brasil.

As a country becomes more developed the infrastructure and building necessities become more service oriented and therefore demand for steel diminishes. A case for steel would logically be India as the successor of China in growth and infrastructure building, but it is forecasted that India will mostly be self-sufficient in its steel production.

As low commodity prices limit new investments and commodities are cyclical, somewhere down the line another surge in iron ore prices can be expected. But, according to Wood Mackenzie such a situation should only emerge after 2025 or even later, as current capacity is enough to cover demand and increased production will probably lead to a long term oversupply.

7 figure supply

Figure 6: Supply comfortably exceeds demand for the next two decades. Source: Wood Mackenzie.


Considering everything above, iron ore seems a tricky asset. High availability excludes a copper scenario where it is known that mine grades are bound to be lower in the future. Long term oversupply and a shift in the Chinese economy from a manufacturing and heavy infrastructure investing one to a more service oriented one does not make a strong case for iron. But, iron ore prices have fallen more than 75% from their 2011 peak so there should be opportunities to make profits. Perhaps iron ore should be left to traders that have the stomach to weather huge swings and the knowledge to seize the volatility as the price is influenced by oversupply in the long term but also by short term euphoria like the in the last two months based on increased lending and hopes of a return to previous levels in Chinese infrastructure growth.