Rexam (REX)


Bullish lesson from blast furnaces

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Need more evidence the world is nowhere near as troubled as most think? Look at iron ore prices.

Maybe you've never, ever thought of iron ore prices. And why would you? An unsexy bulk commodity and chief input to steel-making blast furnaces. Except iron ore prices portend a lot about the economy - chiefly that the US likely isn't going into recession soon. I'll show you how and why. With the overall world growing, and emerging markets faster, there's little chance of a global recession in 2012.

Particularly in recent years, iron ore prices have tracked the economy well - more than most commodities because, thanks to the lack of exchange-traded spot and future prices, there's not much noise from speculators. Plot iron ore prices, and you see moves are very coincident - they rise when the economy's growing and fall sharply when it slows or shrinks.

And when iron ore prices have fallen, there's no big countertrend moves. They fall until they hit a relative bottom - no corrective wiggles. When they turn up, it's the same. Iron ore prices rise fairly steadily until reaching a relative peak. When they turn up, that's good confirmation the economy is also reaccelerating. And that just happened.

For example, in early 2008, iron ore prices peaked near $200, then fell sharply, bottoming at $62.50 in April 2009 - shortly before the global economic bottom. Then they surged to a $189.50 peak in April 2010, and fell to $124 by mid-July - during the big 2010 correction.

The global economy slowed some too, then - but didn't double dip. And iron ore prices didn't fall as much as in 2008 because the slowdown wasn't as big. Iron ore prices surged as the economy reaccelerated, hitting a $198 peak in February 2011. They fell to a relative low of $132 in early November, and have since turned up sharply - likely confirming an economic reacceleration.

Interesting observation. But it's not mere trivia - it's rooted in the fundamentals of running blast furnaces. Running them at low capacity is very inefficient - eating into profits. Firms usually run blast furnaces at near full capacity or not at all. If a firm targets 70% utilisation, it doesn't spread that around. It'll run most mills at full (or near full) capacity and shut the rest - this is how most steel firms operate.

And if a slowdown causes equally competitive mills to be unprofitable, they'll all be shut down - causing iron ore prices to fall.

Once stopped, restarting a mill is also costly. Firms won't do it unless they're confident steel demand won't drop again. And recall, they don't want to start a mill and run it at half capacity. When they restart a mill, they're committed - causing demand for iron ore prices to rise - prices too.

And for the same reason you don't get a lot of iron ore speculators, there's not typically stockpiled inventory to work through. Iron ore doesn't lend itself to stockpiling. Ever try to store a million tons of excess anything? Bit tricky. When demand returns for iron ore, it returns. This makes it a good indicator of actual demand, and confirmation the economy is accelerating.

I see no reason the recent iron ore price surge is any different this time. Which means the US is reaccelerating when the world overall is too. The eurozone is a slow spot, but the larger world pulls the smaller troubled spots along. And if there's no global recession, there's little reason to fear a new global bear market is ahead. Be bullish. Start with shares like these:

Italy's integrated energy giant Eni was triple-whammied this year by the Libyan conflict, eurozone worries and a weak gas market. But Libya is stabilising, and production is returning. Recent gas discoveries highlight the value in Eni's upstream operations. Italy isn't the disaster many fear, and in fact may surprise to the upside in 2012. At seven times my 2012 earnings estimate, it is dirt cheap.

Germany's Fresenius Medical Care is the world leader in the growing field of integrated kidney dialysis. It makes the equipment and provides treatment at 2,800 clinics in 100 countries. As folks live longer globally, they'll need more renal care, driving sales. It sells for 14 times my 2012 earnings estimate.

Britain's Rexam (REX) is the world's largest beverage-can maker-with over 70 plants in 25 countries. Two thirds of sales are in America and emerging markets like Brazil. It has lagged since 2009 and got clobbered in the recent correction. I think it's ready for a rebound. It sells at 60% of revenues and 11 times my estimate of 2011 earnings, and has a 2.8% dividend yield.
