There's a familiar pattern with Wall Street and cyclical companies. When an upswing first starts, nobody believes it. Estimates stay low, and analysts and investors hit the airwaves talking about sucker rallies and momentary price spikes that will quickly be reversed. Later, as prices continue to go up, analysts catch on, and estimates and stock prices quickly go much higher. Eventually, though, the market starts to cool, estimates get ahead of reality, and the downward part of the cycle begins.
Now, I'm not saying that the upward cycle in iron is over or that CVRD (NYSE:RIO), one of the world's leading iron producers, has no more room to grow. What I am saying, though, is that we've had a heckuva run already and that even if the long-term demand picture is as good as advertised (namely, India and China gobbling up ever more resources), a pause could still be on the way.
Nevertheless, CVRD's third-quarter results were still quite good. Revenue rose nearly 58% as the core iron business watched shipments climb 8% and realized prices rise more than 70%. Margins also expanded a bit, despite the impact of higher costs. There were some negative impacts from financial expenses, taxes, and currency movements, though, and net income rose "just" 40%.
For me, the interesting thing to watch in the next month or so will be the price negotiations for next year's iron ore and pellets. On one side, CVRD, Rio Tinto (NYSE:RTP), and BHPBilliton (NYSE:BHP) point to strong demand, constrained supply, and pricing for steel that, though off its peaks, is still pretty healthy. On the other side, iron-using companies like Arcelor and Mittal Steel (NYSE:MT) see it differently.
While analysts seem to think that prices will go up 10%-20%, Arcelor's CEO apparently has the delusion that prices could -- or should -- go back to 2004 levels (that is, before the 70% jump this year). It seems that China is the crux of the matter -- prices have fallen, but demand for iron still looks to be pretty high. Clearly, the outcome here will be important: CVRD is already producing about as much iron as it can for the time being, so growth will come primarily on the pricing side next year.
If you've read my prior takes on CVRD, you know that I like the company. And I still do. But with stocks, I play for a big upside with a low downside. We've already seen the "big upside" part of the equation over the past two years with this stock. Accordingly, while I'm still on board with the notion that we're in a prolonged cyclical commodity upswing, I wouldn't be surprised to see things pause for a bit, thus making the stock's risk/reward balance a bit less interesting to me.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
