It looks like all those analysts who believed iron ore would recede and sit quietly in the corner are now eating their words. This is only on a short time horizon and iron ore could very possibly dive in the coming weeks. But will it?
Five week high for iron ore
Last night iron ore gained 4.6%, reaching US$59.22 ton. A five-week high for the commodity. And it has invigorated some faith, in the short term at least. Iron is now sitting at its highest level since 8 March.
Year to date returns are still quite impressive, up a respectful 35.9%. Not bad when 2016 was expected to be the death of minerals and miners.
Source: Business Insider Australia
Chinese steel resurgence
This is only part of the story though. The next question is: why did iron ore rally so aggressively, yet again?
The answer was the same when iron ore prices rallied on 8 March. The continued surge is due to strong gains in Chinese steel prices.
The news and price archive company, Metal Bulletin offered investors a little more detail on steel buying activity within China.
‘Rebar dealers in northern areas raised offers further during the day amid the rising billet prices. In the east, buying interest was hit by the rain, but traders still lifted prices a little, backed by strong rebar futures… Prices in both regions are at their highest level this year.’
Steel producers seem to be a bit more enthusiastic about buying iron ore. Why? ‘Because prospects for demand and the Chinese economy look pretty good’ Maike Future analyst, Dang Man told Bloomberg.
But let’s keep this super simple. The Chinese economy has been sluggish of late. But no one is expecting their economic woes to continue. That means they have to get out of their slump sooner or later.
And the same goes for their steel industry. Many believe China’s steel market to be over saturated and thus declining the demand for iron ore. But ask yourself; will this last for long?
If you believe China will keep using steel to enhance their infrastructure and build their society then you would probably lean towards iron ore appreciating. If not then you might think iron ore prices are slightly over valued and should depress.
Whatever your view is, you should always be informed and always do your research. If further research changes your view on the outlook of iron ore, then use your research to further your investing performance. Do not become a stubborn investor who has a view point which is based on belief and not evidence.
The BHP dilemma
Now we know more of the story. We know what iron ore did and why it happened. It’s up to you whether you think iron ore will appreciate or fall to US$40 levels. It all comes down to research.
But the story isn’t complete yet. We still need to understand how this will affect BHP Billiton [ASX:BHP] and determine if Australia’s biggest miner is a good place to put your money.
Revenues from BHP iron ore business totalled US$16.16 billion in financial year 2015. This was around 36% of their total revenues in the same year. So it’s safe to say that the price of iron ore is a big deal to BHP.
If we take a look at BHP’s share price it also reacts quiet strongly to the price changes in iron ore. The large spike in early March was around the same time of iron ores price spike. And even today BHP is already up more than 4% because of iron ores 4.6% price rise last night.
Source: Google Finance
There were of course other factors affecting BHP’s share price. It wasn’t only iron ore.
I’m not saying that iron ore and BHP’s share price move in sync. What I am saying is that iron ore’s price has very real effects on BHP’s share price.
Where the rubber meets the road
Now let’s use this information in more ways than one. If you believe iron ore prices will rise because of increasing demand for steel or some other factor then you’d probably like the possibility of investing in BHP long term. And if you’re view is the opposite then you might take the opposite view on BHP long term.
The other way we can use this information in regards to negative returns. Do not get scared by negative returns. If you’re an investor it means you make informed decisions with a long term time horizon. By using our BHP example, if you believe iron ore prices will rise in the future and thus look favourably on BHP for the future, price volatility for iron ore and BHP shouldn’t worry you.
Because you’re looking at your investment in the long term. Too many times investors will lose more than is necessary because they are afraid of their position showing up red in their portfolio.
However if you have made an informed decision and can back it up with research and logical business principles then pay no attention to the ‘noise’ of the market.
Junior Analyst, Money Morning
PS: Investing isn’t hard, but people like to think it is. It isn’t that investors are choosing the wrong stocks — though sometimes they do. It’s their emotions which get in the way.
One quote has stayed with me since I was younger.
‘If you’re afraid to fail then you don’t deserve to be successful.’ Charles Barkley, the famous basketball player said this.
I understand that losses are a bad thing. But not even Warren Buffett can win all the time. Buffett averages great returns over the year, but he has definitely had a couple of losing years.
If you’re unsure where to get start, or want to brush up on your knowledge, Money Morning’s Small-Cap specialist, Sam Volkering has written a great report all about simple investing.
In Sam’s report ‘How to Become a Great Investor in Two Simple Steps’ you’ll see why diversification isn’t the greatest idea. And you’ll also figure out your asset allocation in less than 10 minutes.
To get your free copy of Sam’s report, click here.