A version of this article first appeared on Fool.com
WASHINGTON, DC — Glencore Xstrata (LSE: GLEN) profit is all about metals, even through it is known as one of the largest oil traders in the world. As of June 2013, Glencore Xstrata earned just less than half of its earnings before interest and taxes, or EBIT, from copper and various metals, including zinc and nickel. It only earned about 4% from oil, and given the recent lack of volatility in oil prices globally, and a lackluster demand as well, it probably won’t earn much more. But it did earn about 15% from coal.
What Glencore Xstrata does not have is diamonds, and or iron ore. Glencore Xstrata has also just listed its shares in Johannesburg, South Africa. It is the third largest listing by market capitalization.
Iron ore prices will strengthen
Over 70% of iron ore demand comes from China. Import inventories are on the rise, and spot prices have gone from $110 per ton to $132 per ton in the last half year, something of a rebound in a sluggish market.
The 12-month swap remains low and under spot prices at about $118 per ton. Last year this time the 12 month swap ranged from $90-$110 per ton. Analysts predicted a $90 per ton rate for December 2013. They were off then, and they are off now.
An iron ore trader could sell today at $132 per ton and buy back at $118 per ton in 12 months. Equivalently a consumer of iron ore, say a rebar steel-maker in China such as Baosteel, could short stock today and buy it back cheap in 12 months on contract, in yuan.
Short stock tactics today could create a temporary shortage in supply and buoy spot prices through the year, as it would take that long to push iron ore through a smelter, and on to steel billet, rebar, and plates with coke form the coal that would be part of the deal.
How would Glencore get into the iron ore game?
The short answer to this question is: buy diamonds.
But getting back to iron ore, we know that carbon plus iron smelted from ore equals steel (with some limestone added for good measure). Carbon is produced by baking coal into coke.
Glencore knows how to put together the Capesize coal ship cargos that have the same routes and bulk containers as iron ore cargo. The two commodities are often traded together since they join at the hip in the steel production process.
Iron ore is cheap right now and valuations for an iron ore company have trended lower in the past year. Rio Tinto (LSE: RIO) (NYSE: RIO.US) and BHP Billiton (LSE: BLT) have tracked each other at about plus or minus 2% year-on-year total share return. Brazilian Vale, reputedly the largest ore miner globally, has lost an average of 18% annual share return. South African iron ore and diamond miner Anglo American (LSE: AAL) has lost over 30% share return this past year.
Also, and back to the short answer, the other thing Glencore Xstrata does not have is diamonds. South African company Anglo American derives almost 50% of its EBIT through iron ore and about 18% through diamonds.
On the London Stock Exchange, Glencore Xstrata’s (soon to be simply Glencore) market capitalization is about $67 billion. Anglo American hovers at $29 million, and its stock price continues to travel downward. If Glencore were to acquire Anglo American, South Africa would have a global trader at home in the backyard. This deal would not only be interesting; it could be done.
