Why Coking Coal Could Out Perform Iron Ore

In the last twelve months, the iron ore price has been up and down like a five-year old on red cordial.

First it plummeted from $150/tonne last April, to $89/tonne by August – a 40% drop in just four months.

That’s a savage correction.

But then the bounce of all bounces followed

In the four months since the correction finished, the iron ore price has now jumped 74%, to reach $155 /tonne.

Not only has it recovered all the lost ground from last year, but it now sits at a 15-month high. Giddy stuff indeed; and now Deutsche Bank analysts expect iron ore to hit $170 within weeks.

Iron ore stocks have done well on this rally, with BHP Billiton (BHP) up 10.6%, Fortescue (FMG) up 20.7%, and Rio Tinto (RIO) up 27%.

But sitting quietly, right next to iron ore, there is another equally profitable opportunity waiting for investors

While the media have had endless fun writing about iron ore for the last few months, hardly a single column inch has been devoted to the opportunity poised to follow in iron ore’s path.

The commodity I’m talking about coking coal.

After iron ore, coking coal is the main ingredient in the production of steel.

And because steel mills purchase the two commodities to produce the same product, the prices of iron ore and coking coal tend to rise and fall together.

I got my hands on the data for you this morning to prove my point (thanks to ANZ’s commodity research team). I’ve taken the data and produced this chart to show you how the prices typically track each other.

Coking coal: getting ready to rally next?
 

Coking coal: getting ready to rally next?

 

Source: ANZ data, Money Morning chart

 

You can see how the two peaked and troughed together in the first half of 2010. Then after peaking together in early 2011, they both fell for the next eighteen months. And by the time iron ore finished its 40%, four month correction, coking coal had nursed an equally rough 28% fall.

So you can see how closely coking coal and iron ore move together.

However, while iron ore has soared 74% in just four months, coking coal has done nothing.

Actually that’s not quite right, coking coal has in fact fallen three bucks: from $162/tonne to $159/tonne!

This is very odd, and I’ve highlighted it on the chart above. With such a big move in iron ore, you’d normally see an equal or bigger absolute move in coking coal.

What’s even stranger is that the iron ore price has almost caught up with the coking coal price. Coking coal is often twice the price of iron ore. But with coking coal at $159 today, and iron ore at $155, there is an unusually small $4 difference between them.

To me this looks like a clear signal to start running the ruler over coking coal stocks.

Coking coal looks very likely to start following in iron ore’s path soon, and this will help the valuations of coking coal stocks; many of which look very cheap after two long years of pain.

This isn’t to overlook some of the unique factors behind iron ore’s rally, that don’t apply to the coking coal market.

The Chinese have bought aggressively in anticipation of supply disruption from the cyclone season. With a lot of iron ore shipping from the North West of Western Australia, cyclones can limit exports. Aussie coking coal, in comparison, mostly ships from the East coast so is less at risk.

Another factor pushing up iron ore is the iron ore ban in India. Exports from India make up a large part of Chinese iron ore imports, so this has tightened the market dynamics.

These factors only part explain the huge rally. And none of this explains why coking coal has stood still. So I expect it’s just a matter of time before the coking coal price snaps, and starts going back up.

One clear signal to expect this soon is the rising steel price.

Steel price – up 13% in four months
 

Steel price - up 13% in four months

 

Source: ANZ data, MM chart

 

Since iron ore started its colossal bounce, the steel price has increased steadily by 13%.

China is still only halfway through its current 5-year plan, in which 12 trillion Yuan ($US 2 trillion) is committed to developing power, rail, transport and water infrastructure. Importantly, the third year of a five-year plan generally sees the biggest infrastructure spend. This will require a great deal of steel.

With last year’s power transition out of the way, China is now pushing ahead with completing the projects in the current plan. The period after a new Chinese leadership historically sees a jump in economic activity, as they like to make their mark early on.

So 2013 is set up to be a big one for Chinese infrastructure spending, and we can see that in the fast recovering steel price.

Yet, despite all this, there is little action in the coking coal price.

I think this anomaly can only last for so long – and is an investment opportunity worth keeping an eye on.

Aussie coking coal juniors are pretty badly beaten up at the moment, but with a recovery in the coking coal price, investors will start buying them up soon.

And as always, it pays to get set before the crowds descend.

Dr Alex Cowie
Editor, Diggers & Drillers

Money Morning Australia