December 3, 2012

Jay Turner, P.Eng. 416-265-2182

jturner@popecompany.com

Member: Toronto Stock Exchange • Investment Industry Regulatory Organization of Canada • Canadian Investor Protection Fund

Seaborne-traded iron ore prices have recovered to the US$115-US$120/dry metric ton

(DMT) range following the sell-off last August and September that saw spot prices

bottom at US$86/DMT, the lowest level since 2009. The sell-off was largely driven by

slowing demand as steel demand in China weakened over the summer, resulting in high

iron ore inventories at the Chinese ports, reportedly significantly exceeding 100 mm

tonnes at the end of the summer. However, domestic Chinese iron ore prices fared

relatively better after trading at a discount for most of the year, as shown in Figure 1,

before moving back to parity at the end of November. We believe that there were two

significant factors driving the less-volatile movement of domestic prices. The first is the

current-month pricing formula for contracted imports based on spot prices that was

adopted last year. We believe that this new contract pricing mechanism has facilitated

Chinese buyers pursuing “price discovery” in the imported iron ore market. The second

factor is the Chinese steel mills’ willingness to provide a price cushion to their domestic

suppliers in order to maximize their iron ore resource independence. These factors

appear to have been in play as well in the Sep-Nov/2011 period when spot iron ore

prices also corrected as the current-month pricing formula was first introduced.

Although the data for 2011 is incomplete, Figure 2 shows the price performance during

that period when domestic iron ore prices held up better that import iron ore prices.

As a result, it calls into question the nature of swing production. China is generally

regarded as the highest cost producer of iron ore but it’s apparent that price is not the

only consideration and that strategic considerations somewhat muted the domestic

supply response as fewer mines were shut down due to the lower prices. However,

some reduction in Chinese iron ore production has been reported and iron ore

inventories at Chinese ports were reported in late November to be at approximately 96

million tonnes, below the 100 million-plus tonnages reported a couple of months ago

and indicating that the market has tightened since the Summer.

As a result, we are cautiously optimistic that fundamentals have improved heading into

2013, buoyed by expectations that the slowdown in the Chinese economy appears to

have bottomed out and that economic activity next year should increase, supported by

the US$158 billion in infrastructure projects announced by the Chinese government in

early September. However, our expectations are tempered by the overcapacity of

Chinese steel mills acting to mute any rise in steel prices that are currently squeezing

the profitability of most mills and reducing operating margins that could support higher

priced raw material inputs.

While we don’t have a formal iron ore supply/demand outlook, we have done some

analysis with respect to China’s expected impact on the market. We would note that

China had an approximate 55% share of this market in 2011. Our methodology is based

upon forecasting global pig iron production, the principal use of iron ore. Table 1 shows

our global pig iron production forecast out to 2016. We then convert this production

outlook to iron ore demand and compare China’s implied iron ore import demand and

domestic supply. In order to do this, we have assumed an average grade of 62% Fe for

imported iron ore and 3% blast furnace losses. As a result, we are forecasting that it

requires 1.695 tonnes of iron ore to produce one tonne of pig iron. A key consideration

is that China’s reported domestic run-of-mine (ROM) iron ore grade is much lower than

most other regions of the world. While China may subsequently concentrate this lower-

grade ore, domestic iron ore production is reported at the lower ROM grade. Table 2

shows our forecast for iron ore-equivalent demand and Table 3 shows our analysis of

Chinese iron ore requirements.

Iron Ore Market Outlook and Pricing

Figure 1 – Relative Price Performance in 2012 of Domestic

vs. Imported Chinese Iron Ore Prices

Figure 2 – Price Performance in 2011 of Domestic vs.

Imported Chinese Iron Ore Prices

0

200

400

600

800

1000

1200

1400

1600

JanFebMarAprMayJunJulAugSepOctNovDec

Domestic Price

(RMB/tonne)

Import Price

(RMB/tonne)

Source: China Iron & Steel Association, The Tex report

Source: China Iron & Steel Association, The Tex report

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Relative Domestic Price

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2

Iron Ore Market Outlook and Pricing 12/03/2012

As can be seen, from 2006 to 2011, the Fe grade of China’s domestic iron ore production appears to have declined

as the reported tonnes of production increased. Nonetheless, this strategy appeared to be working, as in 2010, iron

ore imports declined by 1.5% compared to 2009. However, this trend reverted in 2011 as Chinese iron ore imports

were up 10.9% compared to 2010 and have increased further by 9.0% year-to-date to the end of October compared

to last year. We are forecasting Chinese iron ore imports to increase this year by 8.0% to 741.2 million tonnes after

October imports were reported at 56.4 million tonnes, implying an additional 132.5 million tonnes of imports in the

last two months of the year.

During 2011, Chinese domestic iron ore production continued to increase, rising 23.6%. However, for 2012, we are

forecasting Chinese domestic production to decrease 2.0%, reflecting the high-cost structure of the domestic

industry that has recently seen some production curtailments due to lower prices.

In the medium term, we are forecasting the Chinese economy to improve next year and into 2014 with growth in

iron ore-equivalent demand growing 7% and 6% in 2013 and 2014, respectively. Based on Chinese domestic iron ore

production growing at 6% (at the same assumed grade of 17% Fe) for 2013 and 2014, we are forecasting Chinese

iron ore import demand to grow by 7.5% and 6.0%, respectively, or slightly slower than this year. We would note

that our assumptions related to the Fe grade of iron ore imports and blast furnace losses make the calculation of the

implied Fe grade of Chinese domestic iron ore production somewhat subjective. However, we believe that the

underlying trend is accurate.

Table 1 – Global Pig Iron and DRI Production

Source: World Steel Association, Tex Report, Pope & Company forecasts

3

Iron Ore Market Outlook and Pricing 12/03/2012

Table 2 – Iron Ore-Equivalent Demand Forecasts

Source: World Steel Association, Tex Report, Pope & Company forecasts

Table 3 – Chinese Iron Ore Demand Forecast

Source: World Steel Association, Tex Report, Pope & Company forecasts

From a global perspective, we are forecasting iron ore demand to increase from 1,940 million tonnes in 2011 to

2,431 million tonnes in 2016, or by 25.3%. If we factor out the impact of rising Chinese domestic production, in 2011

and 2016 we are forecasting iron ore demand of 1,562 million tonnes and 1,981 million tonnes, respectively, or a

26.8% increase.

In terms of new iron ore supply outside of China, Figure 3 shows the announced capacity expansions through 2016

by the five largest publically-traded iron ore producers. We realize that this list is by no means comprehensive due

to the absence of many smaller emerging producers. We would note that the expansion plans for these five

producers in the summer of 2011 were approximately 650 mtpy and the subsequent global economic weakness has

resulted in approximately 200 mtpy being deferred. We would note that each of these producers has different

balance sheets and will likely be using different price points in revisiting plans to re-start these expansions, such as

Fortescue’s (FMG: ASE; Not Rated) 40 mtpy Kings project.

4

Iron Ore Market Outlook and Pricing 12/03/2012

However, we believe it demonstrates that there is ample supply in the development pipeline to satisfy global

demand in the medium term, assuming China maintains domestic iron ore production growth in line with our

estimates.

As a result, we are forecasting a new supply requirement of 436 million tonnes of 62% Fe-equivalent iron ore by

2016, excluding Chinese domestic production, which we are forecasting to increase by approximately 93 million

tonnes of 62% Fe-equivalent during the same period. Of the 436 million tonnes of new demand, we are forecasting

China to account for approximately 263 million tonnes of 62% Fe-equivalent of this amount. We would note that the

timing of the various projects should have an impact on sentiment over the next couple of years but believe that by

2015 the new supply should put fairly consistent downward pressure on prices. Additionally, we believe that any

delays in the projects by these five producers will likely be made up by new supply from smaller producers as well as

vertically-integrated steel companies such as ArcelorMittal.

Beyond 2016, we expect significant new sources of supply to come on-stream, most notably Vale’s Serra Sul S11D

complex and the expansion of Anglo’s Minas Rio mine, both in Brazil, and in West Africa, where Rio Tinto and Vale

are developing the large, high-grade Simandou deposits, amongst others.

With respect to iron ore price forecasts, Figure

4 shows our price forecast for 62% Fe, CFR

China iron ore. We believe that iron ore prices

should improve next year and then peak in

2014 before declining as the significant new

supply currently being constructed comes into

the market. We would note that we currently

don’t foresee a significant catalyst for causing

iron ore prices to spike ahead of this new

supply with exception of weather-related

interruptions such as cyclones and storms

impacting the production chains in Australia

and Brazil. If a weather disruption were severe

enough to cause a prolonged production

outage, we believe that spot iron ore prices

could test the old highs of around US$180/

DMT compared to our peak pricing forecast of

US$135/DMT in 2014.

Our long term price of US$110/DMT, 62% Fe CFR China, is based on our belief that the highest cost sustainable

production in China is likely in the US$120-$125/DMT range due to the strategic emphasis and price support

demonstrated by China towards its domestic production. As a result, we are taking approximately 90% of this value

as our long term price. Assuming that ocean freight rates remain at or slightly above current levels of approximately

US$25 per tonne, our long term price forecast for the Labrador Trough producers would be US$85/DMT, FOB Sept-

Iles.

Announced

Capacity Expansions

Company2012-2016 (mtpy)

Vale170

Rio Tinto200

BHP Billiton85

Fortescue60

Anglo American235

Total450

1

Vale's Serra Sul S11D mine is scheduled to come on

stream in late 2016 and then ramp up to 90 mtpy

2

Only includes Phase I for Minas Rio

Figure 3 – Announced Iron

Ore Expansions – 2012-2016

Source: Company Reports

100.00

105.00

110.00

115.00

120.00

125.00

130.00

135.00

140.00

Iron Ore Price, 62% Fe, CFR China, USD/Tonne

62% Fe, CFR China

Figure 4 – Iron Ore Price

Forecast – 62% Fe CFR China

Source: Pope & Company

Limited forecasts

5

Iron Ore Market Outlook and Pricing 12/03/2012

Pope & Company Limited (“Pope”) is a full service independent investment dealer founded in 1962 by Joseph Pope.

Pope has, throughout its history, offered diverse services including acting as a primary dealer of the Bank of Canada.

Through its growing Capital Markets division, the firm continues to provide innovative ideas to its institutional client

base. With a focus on natural resource and commodity sector investments, Pope has a proven track record of identi-

fying undervalued opportunities. Pope is a member of the Investment Industry Regulatory Organization of Canada

(IIROC) and The Canadian Investor Protection Fund (CIPF).

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