Although steel prices have shot back up from the financial crisis lows, there's a new threat that will impact the bottom line of mining firms for the next few quarters.
Adding to the increasing evidence that the economy is sputtering yet again, demand for steel has waned in recent months. In response to dwindling demand, steel producers worldwide have been decreasing their output. This is reverberating into the commodities market, as the decline in steel production is subsequently causing demand destruction for both iron ore and metallurgical (coking) coal, which are used to produce steel. As you can probably guess, this does not make mining giants Vale
In its latest earnings report, BHP Billiton warned investors that it expected softness in the near term for iron ore and coking coal, despite just achieving record sales volumes for both materials. These resources accounted for around a third of BHP's revenue in its most recent annual numbers. Meanwhile, iron ore alone made up over half of Vale's revenue stream and about a quarter of Rio Tinto's for the most recently completed years.
If, for argument's sake, we assume a significant decline in revenues generated from the inputs to steel due to declining prices and/or sales volumes, then it is not hard to see that each one of these stocks would be affected to different degrees. If BHP Billiton's negative short-run outlook is correct, then Vale is likely to be affected the most followed by BHP and Rio.
In the short term, these mining companies are likely to hit a rough patch, particularly Vale with its large exposure to iron ore and coking coal. However, looking further down the road, if the global economic recovery should regain traction or if massive economic stimulus projects are fashioned, then this near-term hardship could be an opportunity to buy and hold these stocks for some long-term gains. Be sure to carefully analyze both the short- and long-run demand for steel before making any investments in these firms.
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Gerard Torres has no beneficial interest in any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool disclosure policy never bluffs.