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Metals & Mining Outlook & Review - May 2010 - Industry Outlook
By: Zacks Investment Research   Wednesday, May 12, 2010 7:13 PM
Symbols: AA, AAUK, ABX, AKS, AWC, CMC, FCX, HMC, KGC, NEM, NUE, PKX, STLD, TM
Jewelry and investment demand in non-western markets has rebounded from the low levels in 2009, while industrial demand has started to recover in response to an improvement in economic conditions.

The outlook for investment is positive overall, with absolute levels of demand likely to remain well supported by continued economic and currency uncertainty, inflation concerns and the search for diversification. We expect to see a continuing trend among central banks diversifying away from their dollar exposure in their reserves in favor of the proven store of value represented by gold. Barrick Gold Corporation (ABX) and Newmont Mining (NEM) are showing strong levels of production.

WEAKNESSES

The global metal industry is cyclical, highly competitive and has historically been characterized by overcapacity (excess of supply over demand). Overcapacity in the industry could increase the level of metal imports and squeeze metal prices. In recent years, capacity growth in China has significantly exceeded the growth in Chinese market demand. A continuation of this unbalanced growth trend or a significant decrease in China's rate of economic expansion could result in China increasing metal exports.

Key metal consuming industries such as auto, shipbuilding and construction have experienced weak demand in the last year, forcing global metal producers to slacken production levels. U.S. Steel slashed production by almost 37% in 2009, while Korean steel maker POSCO (PKX) had to scale down output by about 10.9%.

As a whole, the steel industry posted weak results in fiscal 2009. U.S. Steel Corp. recorded a net loss of $1.4 billion, or $10.42 per share in 2009, in contrast to a net income of $2.1 billion or $17.96 per share in 2008. In 2009, commercial metals company AK Steel (AKS) posted a net loss of $74.6 million compared to a net income of $4.0 million in 2008.

Despite its relatively higher growth rate compared to the developed world, the outlook for the Indian economy suggests lower growth rates compared to the last few years. Nearly 45-50% of the world gold production is consumed in India. Gold is a luxury item in this economy, and the demand downtrend is most visible in large cities where gold is consumed. A slow-growth, low inflation and low interest-rate environment is a nightmare for the gold market.

Foreign currency is one of the major risks for gold producers, as they usually have their mining operations outside their countries. Revenues and costs for gold producers are primarily incurred in foreign currency. Kinross Gold (KGC) is one of the top 10 gold producers, which has facilities in the U.S., Canada, Brazil, Chile, Russia and Africa. Although it has a diversified clientele, the operations are vulnerable to foreign currency risks. Hence, any adverse movement will affect cash flows and the profitability of the gold producer.

Despite a sharp rise in recent metal prices, future pricing remains uncertain, and we believe continued demand weakness, production resumption by some mills and lower iron ore and coking coal prices as in 2009 may drive prices down again.

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