Fears Of An Iron Ore Price Collapse Create Opportunities In The Labrador Trough

by: Michael Blair

Canada's Labrador Trough has long been home to iron ore production and today hosts mining operations by Rio Tinto (NYSE:RIO), Cliffs Natural Resources (NYSE:CLF) and ArcelorMittal (NYSE:MT). These companies have had a rough ride in the past year, with major declines in stock prices as investors flee the space in the face of declining iron ore demand in China and forecasts for worsening iron ore prices.

In my view, this creates extraordinary opportunity for patient investors who can play future demand for iron ore through the foregoing major producers, or by taking a stake in some of the promising juniors holding large deposits they are developing with world class partners.

Four of the most promising juniors are listed below:

Alderon Iron Ore Corp. (NYSEMKT:AXX) is moving towards commercial production of its Kami project with plans to reach 8 million tons annually by 2017. Its stock price has fallen from over $3.00 per share a year ago to $1.25 per share today, bringing its market capitalization down to $130 million. Hebei Iron & Steel purchased a 25% interest in the project for $194 million and holds 20% of Alderon shares. Liberty Metals became a 15% shareholder of Alderon following a $40 million private placement in January 2012 at $2.67 per share.

Alderon's 75% interest in Kami has a net present value of approximately $900 million at an 8% discount rate.

Labrador Iron Ore Holdings (LBRMF:PK) is a producing operator with 2013 output planned at 2 million tons. Shares of LIM have fallen from a high in the teens only two years ago to less than $1 today. Debt free and with a market capitalization of only $75 million, LIM is a high risk, high return opportunity. LIM recently entered into a co-operation agreement with Tata Steel Corporation's ("Tata") Canadian subsidiary, itself in a partnership with New Millenium Iron Corporation, calling for co-operation in developing their ore bodies in close proximity and shared infrastructure, as well as the possibility of a future off take agreement. In parallel, the Tata unit purchased a 51% interest in one of LIM's deposits for $31 million, providing LIM with working capital. LIM begins its seasonal shipments of Direct Shipping Ore ("DSO") this month. Whether these will prove profitable depends on the realized price from Chinese customers and the costs LIM will incur, both of which have been volatile for this start up producer.

New Millenium Iron Corp. (OTCPK:NWLNF) is also a producing operator with a 20% interest in a DSO operation held jointly with Tata Steel's Canadian subsidiary, expected to ship 1.8 million tons in 2103 rising to over 4 million tons of iron ore annually as the project develops. NML shares have dropped from over $2.00 last year to less than $1 today.

NML is also developing a partnership with Tata for very large taconite reserves, holding more than 9 billion tons of iron ore. With a capital cost in excess of $6 billion, the Tata connection is vital. Tata is providing debt and equity funding for the project, with NML having a 20% free-carried equity and the opportunity to increase its share to 36% by investing its share of the equity portion of the financing. NML's ability to fund such an increase will depend on when the go-ahead decision is taken by Tata, the extent of its cash flows from its 20% interest in the DSO operations, its working capital at the time of the decision ($63 million at December 31, 2012), and, the enthusiasm investors have for its shares should it go to market for the funds.

Adriana Resources (OTC:ANARF) is developing one of the largest iron ore deposits on the globe located in Nunavik, P.Q. holding over 20 billion tons of iron ore. Shares of ADI have fallen along with iron ore prices.

Capital costs for Adriana's Lac Otelnuk project are expected at over $9 billion, with a net present value of approximately $15 billion ($6 billion to Adriana's share). WISCO has purchased a 60% interest in the project, paying Adriana $120 million and holding a 26% stake in Adriana. Managed by Allan Palmiere - the previous CEO of Hudbay Minerals Inc. - Adriana is an extraordinary but highly risky opportunity for long-term investors.

The time to buy junior mines is when the environment is the most hostile to their success. The ore bodies do not change with investor sentiment. What makes these juniors compelling is their joint venture relationships with Tata Steel, WISCO and Hebei Iron & Steel. These world class steel companies are looking to their Canadian joint ventures as a long-term source of iron ore needed in their steelmaking operations.

Today, with fears of slowing growth in Asia and a forecast surplus of iron ore, these companies have come under selling pressure and have suffered severe drops in market value. The risk of a long-term softening in world economic conditions could postpone the development of these resources for many years, and the development itself requires billions of dollars of capital not only for mining but also for electrical power, pipelines, railroad capacity and port facilities. It is in some respects the sheer size of the projects and the obstacles to their development that have caused investors to shrink away.

But, if you believe (as I do) that long-term growth in India, Vietnam, Indonesia, Singapore, Russia and China is a reasonable likelihood, then the demand for iron ore will grow together with the investment in infrastructure and later in consumers durables in these large markets. In parallel, the large, high grade iron ore deposits in safer jurisdictions such as the Canadian Labrador Trough are in line for development, and the juniors that own these deposits in partnership with world class steel companies stand in time to be major beneficiaries. Patience will very likely be rewarded, although not for the faint of heart.

I hold investments in all of the junior companies mentioned in this article.

Disclosure: I am long AXX, OTCPK:NWLNF, OTC:ANARF, OTC:LBRMF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long all of the companies reviewed in this article.