KENWOOD, CA (Gold Report Interview) –
The Gold Report: Dundee Capital Markets recently revised its commodity prices, most of which are forecast to go higher. Dundee has a long-term gold price of $1,125/ounce (oz.) for beyond 2015. While that is up 5% from previous projections, what in gold fundamentals leads Dundee to such a bearish forecast?
Rodney Cooper: We review our metal prices quarterly. We increased our 2012 price by 11% to $1,750/oz. Today, gold is at $1,763/oz., so I would say that that’s a reasonable view. For long-term pricing of gold and silver, our team reviews the 36-month trailing average prices. That methodology is endorsed by the Securities and Exchange Commission for mining companies to estimate resources and reserves.
With base metals and iron ore, we review the marketplace for the marginal cost of production for the commodity. We typically set our long-term pricing with some reference to that marginal cost. Quarter-by-quarter and year-by-year, that marginal cost can change. In recent history, that marginal cost has been creeping upwards.
TGR: Dundee pushed up its price for iron ore by 24%, to $182/ton, in 2011. From 2012-2016, the average annual increase is about 35% each year. What are the catalysts behind that increase given that the economic outlook is fairly bleak and China’s economy is cooling down?
RC: I first got heavily involved in iron ore back in 2006 as chief operating officer for Baffinland Iron Mines-a baptism by fire into the iron ore space. Back in 2006, and ever since then, there has been a sense that the growth in steel demand has been relatively strong. Demand growth is moderating; nevertheless, demand growth is a reality in the marketplace. Industry observers have said, “Well, you know, there’s a lot of supply coming on.” We are finding that there are a lot of projects on the books, but the capacity of the mining companies to actually deliver on this new supply seems to be restrained.
My revisions to the iron-ore forecast in the near term reflected where the market has gone this year. Year-to-date, it is sitting at about $183/ton. My forecast is now at $182/ton. My long-term price, going out to 2018 or 2019, is down to $90/ton-half of where we are now.
I expect to see the marginal costs remain high. The marginal cost producers are in China. I expect to see prices eventually moderate because of new supply, but the timing for that new supply gets pushed out further and further each year as the news flow comes in and we hear about projects that are delayed or deferred.
TGR: Peter Hopely, a steel analyst with UBS Securities, produced a chart that has demand outstripping supply right now, but supply outstripping demand by 2014. Do you agree with that forecast?
RC: I absolutely agree that supply will catch up to demand. When I first started in iron ore in 2006, everyone was predicting that would happen in 2012. Now there are some forecasts that it will be 2014 or 2015. I’m forecasting that it will take a little bit longer for that to occur.
We’ve seen some capacity constraints. For example, there are infrastructure development constraints in Western Australia.
Most of the new projects are being sponsored by the large seaborne players in iron ore. These companies have seen their levels of relative debt come way down. They have very strong balance sheets. They’re flush with cash. These are all organizations with a great deal of capacity and ability to develop new projects, if they don’t have interference from governments and circumstances beyond their control. I’m not going to bet against the large companies bringing the supply on eventually-but the point is eventually. We will start seeing that gap, but I’m estimating a little bit further out in time.
TGR: What is China’s role in all of this?
RC: China is the driver for a whole variety of commodities. Chinese imports of seaborne iron ore are probably the most important driver in the iron-ore market. In the first half of this year, imports of iron ore into China increased 8% despite all the talk about the marketplace moderating. Levels of activity are still extremely high.
Steel output in China is 1.9 million tons (Mt.)/day, which is huge compared to an average 1.7 Mt./day last year. As countries urbanize, the intensity of steel production grows. In countries such as South Korea or Taiwan, the intensity of steel use is triple the intensity of steel use in China. Urbanization is at 80% of the population in some of those industrialized countries where China is only at 40%. Looking forward, we see literally hundreds of millions of Chinese moving into urban centers.
I absolutely buy into the recent economic outlooks that forecast that Chinese growth is moderating. While there will not be double-digit growth anymore, there will still be about 8% growth.
Looking forward just three or four years, Chinese imports of seaborne iron ore are expected to grow 20%, which would add an additional 200 Mt. of iron ore that has to be delivered into the Chinese marketplace. Layer on top of that coal and other ingredients required for making steel and there could be huge demand growth in seaborne requirements.
TGR: Are Chinese companies going to get into the mining game to the point where they’re competing directly with major players?
RC: There is a certain level of domestic Chinese iron-ore production, which represents about one-fifth of consumption. The Chinese government is trying to reduce the number of polluting, energy-inefficient operations. They are closing coal mines and small iron-ore mines and requiring many regional operations to consolidate.
I’ve looked at iron-ore projects in China where the company is actually producing a profit from ore that is grading less than 10% iron. Outside of China, this is virtually unheard of. Those are the kinds of operations that are dropping away. In fact, we don’t see any growth in domestic Chinese production of iron ore simply because there are so many of these small, inefficient operations that are falling by the wayside. As demand grows, the need for additional seaborne iron-ore increases.
TGR: Let’s move on to copper. Dundee also raised its price projects for the red metal, albeit only by 8% in 2011. But then it gets interesting. The revised price projections for copper jump an average of 25% from 2013-2015. What is driving those increases?
RC: We look at marginal cost of production. Year-to-date copper is at $4.26/pound (lb.), but we’re forecasting $4/lb. next year and $2.50/lb. over the long term. We’re dialed into the current reality. Much like iron ore, the Chinese are driving the demand for copper. We are expecting copper fundamentals to be favorable in the near term. There were deficits in supply last year and this year. Moving forward, we think that the marginal cost of production is somewhere around $2.50/lb. As time goes on, we may see a rerating.
The fundamentals for copper out a few years are exceptionally strong. Regardless of what level of future demand growth you project for China, the industry is running out of projects to fill the supply pipeline. This is going to be a fundamental realignment of the copper industry. We have gone to a new plateau and we are all accepting that as the new reality. In a few years, as cost pressures continue, we may very well see a rerating of copper prices up to a new plateau beyond where it is sitting now.
In the meantime, Dundee is sitting fairly conservatively with a $2.50/lb. long-term price representing the marginal cost of production. That’s pretty much in line with many analysts and market commentators. But I do think that there could be a long-term price rise-and it could perhaps rise dramatically.
TGR: Do you have some final thoughts?
RC: Iron ore and copper are the two commodities that I highly favor at the moment. I’m constantly on the lookout for relatively early stage stories that have attributes that would lead them to capital appreciation and to put companies into an acquisition dynamic with bigger companies. In the last year, I have had seven of my names acquired, so I’m doing a reasonable job at picking the ones that are attractive to the big companies.
TGR: That’s great. Thanks.
Rod Cooper is a professional mining engineer with nearly 30 years of varied international experience in corporate development, engineering and operations. Prior to joining Dundee Securities as senior analyst in the base metals and iron ore areas in November 2009, he was chief operating officer for Baffinland Iron Mines, the owner of the Mary River project in Canada’s Arctic region. Prior to Baffinland, Rod was vice president, technical services for Kinross Gold Corporation. He has also worked for Homestake Canada, Echo Bay Mines, Inco Metals and the TD Bank. He graduated with a degree in mining engineering (Honors) from Queen’s University in 1980, and with a Master’s degree in business administration from the University of Toronto in 1984.
The above article is abstracted from a longer one published by The Gold Report. The full article, complete with some stock recommendations, can be accessed on http://www.theaureport.com/pub/na/10756