Sands sector’s strategic shift

The heavily sold mineral sands industry is digging deep to orchestrate an upturn in ore prices.

Summary: Mineral sands producers saw their share prices plunge last year amid declining demand. But the industry is fighting back to spur a recovery in ore prices, and their shares, though production cutbacks, running down ore stockpiles, and by ending legacy price contracts.
Key take-out: The mineral sands industry needs to balance out production discipline with meeting long-term demand.
Key beneficiaries: General investors. Category: Growth.

Iron ore wasn’t the only mineral whacked by a sharp price correction in the middle of last year, and it will not be the only mineral to stage a recovery, which is why investors should be looking for early signs of revival in titanium and zircon miners.

So far there is not a lot to see, but that’s ignoring the fact that companies in what was once called the mineral sands (or beach sands) business are busy orchestrating a resurgence based less on the mining process itself and more on smart marketing and production controls.

Iluka Resources, the local “sands” sector leader, and Rio Tinto, the diversified major miner with the biggest exposure to titanium and zircon, are directing a producer fight-back against last year’s collapse in demand. This could spark a price rebound similar to that which has occurred in iron ore.

The key to what’s happening is the elimination of long-term sales contracts, which have inhibited the sands industry for decades. They have been replaced with short-term pricing of the “market clearing” sort introduced by BHP Billiton’s departing chief executive, Marius Kloppers.

Stocks to watch as the contractual transition flows through the sands miners include:

  • Iluka (ILU), which collapsed spectacularly last year, falling from a high of $18.40 in April to a low of $7.36 in November, but which has since clawed its way back to around $10.18.
  • Mineral Deposits (MDL), which was cut in half last year when it fell from $6.62 in March to $3.06 in December, but which has since risen to around $4.15 with interest growing in its soon-to-start Grand Cote mine in the west African country of Senegal .
  • Base Resources (BSE), which fell from 58c in March to 22c in October, but which has recovered to 37.5c as it passes the half-way point in building the Kwale mine in the east African country of Kenya.

Other sands miners worth keeping an eye on despite being in the micro-cap category are: Gunson Resources (GUN), which has moved to within sight of developing its long-stalled Coburn mine in WA, and MZI Resources (MZI), which is developing a new mine at Keysbrook close to Perth.

Interesting as each company might be, the important change occurring in the sands industry is taking place at a level above any particular mine. The biggest producers of the key products (ilmenite, rutile, leucoxene and zircon) are reversing the pressure they suffered at the hands of buyers last year though production cutbacks, which are starting to bite.

Rio Tinto, which controls an estimated 34% of the world’s titanium minerals production, has mothballed part of its big Richards Bay operation in South Africa.

Iluka, which is Australia’s major producer of titanium minerals and zircon, has closed marginal mines in WA and trimmed production at other mines.

Those producer responses to a sudden collapse in demand from consumers of titanium minerals (mainly the paint industry which uses titanium dioxide as a pigment) and zircon (ceramic tiles) has started to reverse a precipitous plunge in prices for the minerals.

Zircon, for example, plunged in the second-half of last year from around $US2400 a tonne to $US1500/t. Rutile (the most valuable of the titanium mineral products) fell from $US2500/t to less than $US2000/t.

Closing mines was a first step in a conventional producer fight-back. The second step being taken now is also conventional, which is the selling of a high level of surplus minerals in warehouses built up after customers withdrew from the market.

The third step is the interesting one, and is the shift in the sands industry that has the iron ore hallmark stamped on it – the end to “legacy” contracts.

Under a system which had operated for decades, the major buyers of titanium minerals, such as Du Pont and other giants of the chemical and paint industries, offered miners long-term contracts with tight price controls.

Iron ore operated in a similar way, but miners were able to exert pressure during the annual price-setting season.

Kloppers broke the iron ore system by demanding, and getting, a “price of the day” sales process that started in early 2009 when iron ore was selling for about $US60/t. Within 12-months, iron ore had soared to around $US150/t, and then up to its all-time high of $US200/t in 2011.

Being exposed to overnight pricing brought its challenges for the iron ore industry, as last year’s sudden withdrawal from the market by big Chinese steel mills demonstrated. Rather than buy fresh supplies, the mills opted to run down their stockpiles – causing the daily-traded iron ore price to collapse to $US85/t.

Normality has since returned, with buyers back in the market after running down their stockpiles, and this has lifted the iron ore price to around $US150/t.

What happened in iron ore pricing is starting to happen in titanium minerals (but less so in zircon), with Rio Tinto reporting that in 2011 all of its titanium products were sold under legacy contracts. Last year the ratio changed, with about 80% sold under legacy contracts and 20% sold on a short-term basis.

This year, the ratio flips around to 80% short-term and 20% long-term, a result of the long-term contracts (some running for 10 years) being worked out. By 2015, all of Rio Tinto’s material will be sold on a short-term pricing basis – much like iron ore.

Two questions flow from the marketing changes underway. Firstly, what effect will the change in marketing have on titanium mineral prices and, secondly, what’s happening to zircon?

In titanium minerals, the investment bank Investec sees a skyrocket effect, with titanium dioxide (sold as a product called chloride slag) rising from $US730/t in 2012 to an average of $US975/t this year and then up to a boom-time price of $US1750/t in 2014.

Zircon is different and affected by different pressures, including substitution by ceramic tile makers who have learned to use very thin coatings of the material on top of their tiles.

Understanding the nature of the zircon market even led Iluka to undertake a detailed study of the Chinese ceramic tile industry, collecting and analysing the amount of zircon (the loading per tile) from 270 samples, coupled with data from 700 ceramic tile agencies.

The result was a better understanding of the Chinese tile industry and this comment buried on slide at the back of Iluka’s latest management presentation: “it’s all about marketing”.

Broking firms following the sands and zircon industries closely are not convinced that all the bad news about last year’s price collapse has yet been felt. Goldman Sachs retains a sell tip on Iluka, although it acknowledges that an improvement in mineral prices is on the way.

Iluka itself has warned that conditions last year were actually worse than the 2009 collapse caused by the global financial crisis, with the aftershock jeopardising its dividend policy.

On a more positive note Iluka’s management believes “more favourable demand conditions” were expected to emerge progressively during 2013.

Sales of zircon in January were higher than last year and inquiries from buyers had stepped up.

What that means from an investment perspective is that the worst of the downturn has passed, and it is now a case of watching how long the miners can maintain production discipline and whether existing and new mines will be able to satisfy long-term demand.

Investec thinks the outlook is extremely positive, a view based on a forecast made last year by Rio Tinto that total world demand for titanium minerals will rise from 6.5 million tonnes a year to 9.5 million tonnes a year by 2020.

Supply, however, from existing and new mines, is expected to increase initially to 7.4 million tonnes and then stabilise at 7 million tonnes, leaving a potential global deficit of 2 million tonnes a year – a situation that will force prices up sharply, if it happens.

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