The “Iron Mountain” comes down again; BUY FMG
While Chinese iron ore stockpile data isn’t 100% reliable, like all Chinese data, the trend of the data is more important than its absolute accuracy.
The good news for Australian iron ore exporters is that the trend of declining Chinese port stockpiles continues. This is having an inverse effect on “spot” iron ore prices which have recovered sharply off their lows and now imply a drop of just -15% in benchmark iron ore contract prices this year.
There are signs of hope in iron ore with Chinese stockpiles falling, spot prices rising and the Baltic Dry Shipping Index +50% off recent lows due to demand for iron ore ships. Usually at this time of year the Chinese are doing everything in their power to talk down the iron ore market and keep spot prices under control. This time around all the indicators are moving in the iron ore producers favour ahead of the contract price negotiations.
Similarly, Chinese steel mills have been RAISING prices for HRC and slab and those price rise are sticking (I remain of the view OST, BSL and SGM are medium-term bargains down here). It’s also reported that Chinese steel mills are running low inventories of finished product and are starting to ramp up production in anticipation of demand increasing on the back of domestic stimulus packages. It appears to worst of Chinese steel industry capacity utilisation is behind us and you can see this clearly in the inventory, spot price and BDI recovery.
We have written for some time that we believed consensus iron ore contract price forecasts were “too pessimistic” (some down -50%) and likely to be upgraded as we got closer to the contract price negotiations and that does seem to be occurring. BHP appear to share that view and are said to be delaying the negotiation process to move the situation more in their favour. As much as it sounds impossible, I think the Australian iron ore sector is “cum consensus upgrade” when iron ore contract prices settle down only -25%. With the currency also down -25% this would be a great outcome for Australian producers who report in Australian Dollars. Could this be an example of “short the rumour, buy the fact”?
Fortescue (FMG) remains the leveraged and liquid pure play on iron ore and they did report a record December quarter of production. The cash position is $430m and margins remain strong. I think the shorters of FMG were surprised by the year-end cash position and record production. The shipping target for the next six months is 17.6mt. 17.6mt x US$75t divided by .6500usc = $A revenue of A$2.03bil for the next half. Yes, all things going well FMG will book A$2bil of revenue in the next half at a margin of around 55%. FMG has no bank debt, just bond holders. It’s biggest cost is diesel prices and they are down sharply. CEO Andrew Forrest will be presenting in our office tomorrow night to institutional investors. FMG continues to look an extremely cheap stock and I am staying on this ride.
Iron ore, in Australian dollars, continues to look dramatically better than coking coal where the price decline will be extremely unpleasant. Long iron ore short coking coal??