Vale SA (NYSE:VALE) investors have seen the company's shares fall around 10% so far this year. Worse, the shares have fallen over 60% since early 2011. This would normally be the pattern for a company in trouble. While that's not the case here, there's still reason to be concerned about the future at this giant miner.
It's all about supply and demand
Vale's biggest product is iron ore, which accounted for roughly 70% of the miner's revenues in the second quarter. The rest of its business comes from nickel, copper, coal, and fertilizers, among others. While having a little diversification is good, at the end of the day, iron ore is the make-or-break product.
The problem is that the steel industry, which is the main customer for iron ore miners, is in something of a state of flux. In 2010, China's gross domestic product (GDP) grew a robust 10.4%. That marked a return to double digits after two years in the 9% range. However, since that time, the world's most populous nation has seen its GDP growth drop into the 7% area. Note that this slowdown in growth pairs up pretty well with Vale SA's share price decline.
That's because the world geared up to supply China with all manner of basic materials, including iron ore, to support its massive growth. Around 35% of Vale's sales were to the country in the second quarter. China is a big customer, and its growth, while still robust on a relative basis, is starting to ebb on an absolute basis. That's put the steel industry and its suppliers into a balancing act between the near term and long term.
Why? Because a country can't grow without steel to build long-lived assets. In other words, Chinese demand isn't going away even if its growth is "just" 7% or so. But new mining projects take time to get going, so demand from China slowed just as iron ore production was ramping up. Supply has, thus, swamped demand and has inevitably led to low iron ore prices. That's true even though long-term demand from emerging economies like China and India will continue to grow.
And the discrepancy between supply and demand is huge, with Goldman Sachs Group estimating that "the trend rate of growth in seaborne cargoes exceeds demand by a ratio of three to one." Demand for iron ore hasn't gone away, it's just not robust enough to sop up all of the available supply—right now.
A long-term view
Since the giant miners are looking to prepare for the long term, however, they still haven't slowed down. For example, Vale is looking to expand its iron ore volume by over 40% between 2014 and 2018. Most of that increase is scheduled to come from expansion of the company's mining efforts.
So, in many ways, Vale is helping to create its own problems. And the impact of this oversupply has been huge, with Vale's sales price for iron ore going from a touch over $126 a ton in the first quarter of 2011 to $81 a ton in the just-ended second quarter. Iron ore pellets fell from about $181 a ton to a touch under $136 a ton over that span, as well. No wonder the share price has fallen so much.
The price trend isn't getting any better. Iron ore prices fell 10% sequentially between the first and second quarters. Pellet prices dropped nearly 8%. Clearly, the trend is going in the wrong direction. That said, Vale highlights the positives of low prices: "The increase in supply from the majors has pressured prices downward and has led to the closure of high cost iron ore miners and the reduction of exports from non-traditional suppliers."
However, the impact of increased supply from major players like Vale is likely to keep the price of iron ore weak. And that, in turn, will keep miners like Vale in the stock market dog house -- at least until demand starts catching up to supply, which will, eventually, happen. So Vale's 10% price drop this year is just a continuation of a supply/demand story that hasn't fully played out yet.