Rising Nickel Prices Unable to Pull Vale SA Shares Higher

Nickel prices have been surging over the last month as tensions in Ukraine and possible sanctions on Russia raised concerns over the supply of the metal. Nickel supply is also hurt by the Indonesian ore export ban, the same ban that hurt Freeport-McMoRan's (NYSE: FCX  ) first quarter copper sales. Vale SA (NYSE: VALE  ) , which produced 67,500 tons of nickel in the first quarter, is a clear winner from the current nickel market. The nickel price increase was unable to pull Vale's shares into positive territory, however, and they continue to trade at levels lower than at the beginning of the year.

Nickel accounted for less than 10% of revenue in the first quarter
Iron ore has the biggest share in Vale's revenue mix. The company's ferrous minerals segment accounted for 71.7% of its revenue in the first quarter, down from 76.7% in the fourth quarter of 2013; lower iron ore prices, combined with lower sales volumes, hurt the segment revenue. Nickel was the largest contributor in Vale's base metals segment, accounting for 9.6% of first quarter revenue and growing its share from 7.2% in the fourth quarter of 2013.

Despite the growth of nickel's share in total revenue, Vale's ferrous minerals segment results are a much bigger driver of the company's valuation. The most dramatic nickel price move happened in April, during the second quarter. We can expect nickel's revenue share to increase going forward. Even with such an increase, iron ore will play a dominant role in determining Vale's fate.

Concerns over Chinese shadow banking system put more pressure on iron ore prices
Iron ore prices found themselves under increased pressure as China's banking regulator decided to investigate iron ore financing deals. The possible outcome of this investigation could be a massive sale of iron ore, a move that would pressure prices further. During the recent earnings call, Vale's management was asked about the amount of Chinese iron ore inventories that are tied up in financing arrangements. Vale stated that it was difficult to assess the exact quantity of such inventories, but showed cautious optimism that the number was not huge.

It's highly likely that nobody knows the exact answer to such a question. This fact adds to the nervousness of the market and pushes prices lower. China is Vale's largest customer, so negative news from the country will put additional pressure on Vale's shares.

Also on the iron ore front, Rio Tinto (NYSE: RIO  ) is suing Vale over the loss of rights over the Simandou project in Guinea. However, it's too early to assess the possible impact of the lawsuit as it has just been filed. The only thing that one can say for sure is that this lawsuit has the necessary characteristics to become a lengthy and possibly costly battle between the two giants.

Bottom line
Despite the rise in nickel prices, all eyes are on the iron ore market. Vale's high exposure to China adds to investors' concerns, but the company's low cost profile must support the current valuation. It's difficult to imagine that iron ore prices will dive deeper for a prolonged period of time, though, as too much production will become uneconomic.

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