X - Get Report) CEO John Surma said, "The overwhelming dynamic affecting the pace and level of our industry's return to profitability today is the state of the raw materials markets." Quarterly iron ore pricing implemented by mining giants Vale ( VALE - Get Report), BHP Billiton ( BHP) and Rio Tinto ( RTP) may help them realize higher iron ore prices during the remainder of the year. Seaborne iron ore prices soared 90% during the second quarter and are poised to increase by 25% during the third quarter. In the current environment of slowing steel demand, it will be difficult for steel producers to pass the hike in raw material costs to their customers. Iron ore prices will increase an average of 12.4% during 2011, according to Morgan Stanley. Given the escalation in iron ore prices, steel producers will increase hedging against volatile iron ore prices using iron ore swaps.
Steel producers have been emphasizing vertical integration more than ever before. For instance, ArcelorMittal plans to expand iron ore capacity to 100 million tons from 60 million tons within the next five years to protect itself against price volatility. Currently, the company has 45% self-sufficiency in iron ore at a 100% utilization rate. In the current scenario of increasing raw materials costs, integrated steel producers such as U.S. Steel and ArcelorMittal likely will outperform industry peers. Going long ArcelorMittal and shortingAK Steel ( AKS) may provide superior risk-adjusted returns during 2010. Iron ore heavyweights such as the three big mining giants and Cliff Natural Resources ( CLF), a metal stock-pick for 2010 may generate higher returns for investors.