So right now I am going through the miners in the Labrador trough area:
- Alderon (Altius Minerals owns a large stake in Alderon)
- MFC Industrial (MIL) owns a royalty on Cliffs’ Wabush mine
- Cliffs (CLF)
- Champion Minerals (CHM.TO)
- Labrador Iron Ore Royalty Corporation (LIF.UN)
- New Millennium Iron Corp (NML)
- Adriana Resources
- Zone Resources
- Oceanic Iron Ore Corp.
(I am obsessed with Altius Minerals ok? See somebody else’s writeup on VIC.)
The short version of what I have to say
I would avoid all of the juniors in the area and just stick with Altius Minerals. LIF.UN may be ok but I am not really interested in it.
Cliffs’ Bloom Lake mines have a cash cost of $91/ton (see their quarterly results and forecasts). Cliffs is guiding down towards a lower cash cost towards the end of the year ($85/t for the full year). I would expect the juniors in the area to have cash costs similar to Bloom Lake or higher. Many of their technical reports were done with some involvement by BBA and the technical reports all anticipate operating costs of roughly half of the current Bloom Lake figures. BBA did some technical report work for the Bloom Lake project when it was owned by Consolidated Thompson… those numbers were way of. As far as the juniors in the area go, I expect these deposits to have cash costs of $85-91+/t.
Iron ore economics
Iron ore from mines will vary in their chemical and physical composition. They may contain deleterious/unwanted elements like too much aluminum, silica, sulfur, phosphorous, manganese, and water. Some of these elements may make it more expensive to refine the iron. Ore with undesirable levels of deleterious elements will sell for less (if it even sells at all) after smelter penalties/deductions.
Physically, iron ore is sold as fines, lumps, and pellets. For some mines, the iron ore is ground very finely so that the ore can be upgraded to remove unwanted elements and to increase the grade (“beneficiation”). Ore that is really fine is classified as iron ore “fines”. Ore that is coarser is classified as “lumps”. Fines sell for less because they cause problems when smelted. Some smelters can apply a sintering process to the fines so that they can be smelted. In some cases, fines are sent to a pelletization plant that converts fines into small pellets. Pellets sell at a higher price than lumps as smelters are more productive with pellets.
Generally speaking, most of the demand for lower quality ore (high in deleterious elements) and for fines is in China. Some iron ore isn’t very attractive in North American or European markets because the ore is too high in deleterious elements. They may only find a buyer in China.
Shipping the final product can be a substantial cost. Iron ore generally ends up being shipped by sea as that is the cheapest way of moving material. Usually the mining company has to build a railroad to connect the mine to a port. Depending on the distance, the cost of a railroad can sometimes be a significant capital cost.
The lower/higher margin producers
The grade of the ore matters but perhaps not as much as you would think. In China, some iron ore mines have a grade of only 20%. This is possible because the ore can undergo mineral processing to create a concentrate product that can be sold. (Most iron ore concentrates have a concentration of 60-68% iron.) Low grade ore has higher operating costs (more material needs to be moved) and higher capital costs (to build a processing plant with sufficient capacity). Overall the grade of the ore isn’t always the most important factor.
The quality of the final ore concentrate can make a difference. This will be an issue for Alderon. Alderon’s PEA assumes quality deductions of $15/ton (likely due to the high manganese content). Alderon will be hurt again because their ore has to be shipped a long distance to China (it is too low quality for North American and European customers). Alderon is sometimes compared to Consolidated Thompson which was sold to Cliffs for $4.9B. However, Alderon would be a lower margin producer than Consolidated (if it actually turns into a mine) and will not fetch anywhere near Consolidated’s price.
Future iron prices & China
Future commodity prices are very hard to predict in my opinion. Considering the meteoric rise in iron ore prices (see indexmundi.com for historical prices) as well as the huge increases in iron ore supply, it seems to me that eventually there will be a wave of overbuilding that will cause a crash in prices. This happened for nickel and drybulk shipping. China will probably play a large role as it has an unusually high level of demand for iron ore to feed its steel mills. China has a real estate bubble (in coastal cities) that is coming back down to earth. Less housing starts may significantly reduce demand for steel.
On the other hand, it could be possible that iron ore prices stay at current levels (or continue to rise). While China probably has too many apartments for now, there are areas where its infrastructure is lacking. 37 people lost their lives in a flood and residents are angry at the poor state of the sewer system. The Chinese government could continue to control its economy in a way that pushes the country into continuing to build very high levels of infrastructure.
Personally I expect iron ore prices to come down in the future. It’s cheap to find and a lot of new production continues to come online. New supply will eventually drive margins down.
For whatever reason, analysts and NI 43-101 authors tend to be very negative on future prices. In technical reports, it is reasonable to use a 3-year average for the commodity price assumption. In Alderon’s technical report by BBA, the 3-year average is $135/t but a price of $115/t is used instead. Normally in the junior mining world, you would hire an author who will make aggressive assumptions about the commodity price. For example, the report author(s) could have chosen to use the spot price as it would have been higher than the 3-year average.
What I would do (iron miners in general)
Stay far way from the marginal exploration projects (basically all of the Canadian ones). Bloom Lake is one of the highest cost producers out there. Let’s take a look at cash costs for Cliffs’ various global operations for the first half of 2012:
Bloom Lake: $91/ton
Wabush: $133/ton (this is a legacy mine on its last legs)
At $91/ton, Bloom Lakes’ costs are well above that of Cliffs’ US and Asian-Pacific operations. Eventually iron ore prices will fall and I would not want to be stuck with a low margin mine or deposit. The industry has also seen its operating costs go up over the last several years and I would expect that this trend will continue. There has been shortages of skilled labour, mining equipment (lead times to buy equipment has been getting longer), and diesel.
Miners with high levels of debt (e.g. Fortescue) should likely be avoided. I don’t like businesses that don’t pay attention to Gambler’s Ruin.
Buying options on miners (e.g. the really large ones like Vale, BHP, etc. with liquid options markets) could make sense if the cost of options / implied volatility is really low. The miners with high levels of debt and/or operating leverage would make the options more attractive. So while I would avoid the common stock of heavily leveraged companies, the options may be compelling if they are cheap enough.
Altius Minerals may be the best way to play the mining sector (see commentary below).
Commentary on some related stocks
MFC Industrial (MIL): MFC owns a royalty on Cliffs’ Wabush mine. Wabush is one of the lower margin mines out there (Cliffs says it had operating costs of $133/t in 2012) and may be nearing the end of its life (it has been in operation for decades). Its ore has elevated levels of manganese (see this report that was prepared over concerns that the mine would close and cause Wabush to lose its main employer). In my opinion, it probably won’t see any expansion in capacity and may be one of the first mines to close if iron ore prices were to drop.
Alderon (ADV.TO): Like many other juniors, Alderon does spend money on stock promotion (it “sponsors” theaureport.com and grandich.com). That type of activity doesn’t really generate value for shareholders as a whole. On the other hand, it has been able to raise capital… to the benefit of Alderon’s original shareholders.
On the pro side for Alderon, it has very low infrastructure costs since it is so close to existing rail. On the con side, Alderon will likely be a much higher cost operation than Bloom Lake. Its ore has high levels of manganese and it will receive a lower price because of this. It is also burdened slightly by a 3% royalty to Altius. It is burdened again as Hebei has an offtake agreement that allows it to purchase 60% of production at a 5% discount to the benchmark price published by Platts (and an option to purchase the rest of production up to 8MT/yr at 0 discount to the benchmark price).
Champion Minerals (CHM.TO): Compared to Alderon, it has slightly higher infrastructure costs. This is not a big deal since a $500M difference divided by 15 years and 8MT/yr is only $4.17/t higher cost to produce a ton of concentrate (*the difference isn’t actually $500M… this is just an illustration). On the other hand it will have lower smelter deductions and a lower royalty (2% compared to 3%). It currently doesn’t have any type of off-take agreement.
Its inferred resources may be inflated (their geological interpretations seem aggressive to me) and Champion will need to spend tens of millions of dollars on more drilling and feasibility studies. Its deposit is probably more economic than Alderon’s deposit.
Zone Resources: Because of its small size, it will waste an incredible amount of money on overhead, promotion, and on raising capital. I only bothered to skim it and its properties seem far away from infrastructure. So their properties don’t seem economic unless they find some incredible grades (i.e. 50%/60%+) and tonnages (may need to be a few billion tons minimum).
Altius Minerals (ALS.TO): It owns a lot of land related to iron ore exploration and has announced many joint venture partners who are exploring their land. Their joint venture strategy is smart. For one thing, they can find junior companies willing to do dumb/crazy things (Alderon for example pays for promotion on penny stock sites). Their joint venture partners are essentially ‘buying’ Altius’ land… sometimes not at a very good price. Basically Altius has bought land when it was very cheap, added some value by doing initial exploration work, and ‘sold’ the land to other companies. As they did this before commodity prices went up significantly, Altius has grown book value at incredible rates since inception.
Altius’ obsession with royalties is also smart. It tries to retain a royalty on every property they joint venture out. Generally speaking if the company that owns the deposit decides to do something stupid, it is usually beneficial to the royalty holder. In the mining industry, it is pretty common for companies to do dumb things. They may spend money on exploration or building a mine even if the economics don’t really make sense. This benefits the royalty holder as the royalty holder makes a bonus profit while the mine owners risk losing money on their dumb capital allocation.
Altius is also one of the few mining-related companies that are buying back shares (see Altius on canadianinsider.com).
Other companies in the Labrador trough (CLF, NML, Adriana, Oceanic Iron Ore): I don’t have anything insightful to say.
Other perspectives on iron ore miners
Research report by Raymond James: Iron Ore Reaching for the Peak in the Labrador Trough – great background information. For their valuation of Alderon, I’m not sure if they took into account smelter penalties that Alderon may receive. Also, Bloom Lake’s high operation costs cast a shadow over all the other iron projects in the region in my opinion. BL supposedly has cash costs of $30/t… now it is $85-91/t. I would assume similar costs for all of the juniors in the area.
Alderon report by Scotiabank’s analysts
How business decisions are made in a boom: Fortescue Metals edition – blog post by Hedge fund manager shorting Fortescue and Alderon. I don’t think it’s a great idea to short either company as they are (partially) engaged in real business and could make a killing if commodity prices rise. I’d rather short junk like Gold Resource Corporation and Barkerville Gold. (*I am not shorting either of those companies at the moment. I probably will never short Barkerville and I don’t think Interactive Broker allows it.)
*Disclosure: I own some Altius and used to own MFC Industrial.