The Iron Ore Rally is Done

In today’s Money Morning…iron ore is going strong, but can it reach higher?…the industries that have thrived off Australia’s debt love affair…there’s always a favourite sector in every commodity boom…and more…

Today’s Money Morning starts with an apology…

On Monday, I wrote that the iron ore price had breached the US$100/tonne level. That claim was technically correct, but I used a price that is rarely quoted in Australia, and I didn’t stipulate that was what I was referring to.

I was talking about prices traded on the Dalian Commodity Exchange, whereas you normally hear about prices for iron ore delivered to the Chinese port of Qingdao.

Sorry about that.

To clarify, the Dalian Commodity Exchange currently has the most heavily traded iron ore contract at 716 yuan a tonne, equivalent to US$104/tonne. And for iron ore delivered to the port of Qingdao, as reported by Metal Bulletin, the price is currently sitting at US$91.71/tonne.

I’m not sure why there is such a large discrepancy. But from now on I’ll stick to the port of Qingdao price, as that better reflects the prices received by Aussie iron ore companies.

Still, at over $90/tonne, the iron ore market is very strong. That’s because demand for steel in China is strong. Once again, China’s state directed stimulus has increased construction activity over the past year or so and put a rocket under the iron ore price.

Iron ore stockpiles at record highs

China has also boosted iron ore stockpiles, which currently stand at a record in excess of 120 million tonnes. But, apparently, there is a reason for that.

Word on the street says that Chinese authorities have shut down a lot of inefficient steelmaking capacity over the past 12 months. That means less steel mills that use low grade iron ore, leaving relatively more mills that use high grade, quality iron ore.

Much of the stockpile then, is lower grade iron ore that is in less demand.

This is what Cliffs Natural Resources boss Lourenco Goncalves said about the matter, as quoted in the Financial Review:

“Between the improved profitability of the Chinese mills, the elevated prices of coking coal and most importantly the increasingly serious crackdown on pollution sponsored by the Chinese government, demand for higher grade iron ore has risen significantly,” he said.

“Previously when the Chinese mills were not being forced to pay attention to pollution and coking coal prices were extremely low, low iron content didn’t matter. Now it does matter, and that is why we continue to see higher ore inventories at the ports.

“These port stocks could stay high, or even go further up and that will continue to have a very limited influence on the 62 per cent iron ore price index.”

This may all be true, but credit growth looks set to slow in China this year. If that does happen, you’d have to expect iron ore prices to pull back from here. The Financial Times has the scoop on the credit numbers:

Chinese banks traditionally splurge on lending in January, following the renewal of lending quotas at the start of each year. But central bank data released on Tuesday show new local-currency bank loans were Rmb2.13tn ($310bn) last month, far above the Rmb994bn in December but below the Rmb2.54tn in January last year. It was also short of expectations of Rmb2.30tn, according to a Reuters poll. 

“The huge increase in net new lending in China last month was seasonal. Growth in outstanding loans actually slowed to a 10-year low in January. Broad credit growth also slowed last month and is set to decelerate further in the months ahead,” Chang Liu, China economist at Capital Economics in London, wrote on Tuesday. 

Non-bank lending in January was strong, raising overall new credit, excluding government borrowing, to Rmb3.33tn — the highest monthly figure ever. But analysts emphasised that growth in the total stock of outstanding debt slowed, despite the record high lending volume.

The foot is slowly coming off the stimulus accelerator in China. How much that affects the iron ore market in the months ahead remains to be seen.

Iron ore stocks rally just about done

But for now, my feeling is that the rally is just about done for iron ore stocks. Yesterday, after the near 6% surge in iron ore prices, the major producers barely saw a reaction in their share prices.

For example, Fortescue Metals [ASX:FMG], which is highly leveraged to the iron ore price, saw its share price open at $6.97, then rally to a high of $7.06, before selling off to close at $6.88, unchanged from the day before.

That sort of reaction tells you that buying power is just about exhausted.

Elsewhere, there are more company reports that tell you Australia’s debt fuelled economy is going strong.

Furniture retailer Nick Scali [ASX:NCK] reported a 45% increase in profit in the December half. The retailer put the strong result down to the ‘wealth effect’. That is, higher house prices, driven by low interest rates and other people taking on greater amounts of debt, give people the confidence to go out and spend up on a new sofa.

That’s great for Nick Scali (a very well-run company) but in the aggregate there is no such thing as a wealth effect. That’s because the economy must support greater debt levels to create this effect, and for those who don’t own property, rising house prices and rents create a ‘wealth deficit’.

But in economics, that which is hidden or unseen is often ignored.

Commonwealth Bank profits from debt binge

Another industry that loves debt growth is the banks. This morning, the Commonwealth Bank [ASX:CBA] reported a half yearly cash profit of $4.89 billion, up 2% on last year.

The growth rate may be low, but it’s in defiance of expectations that bank profits would fall as bad debts picked up. But according to CBA, the bad debt cycle is still benign.

While I don’t see the rate of profit growth picking up much in the short term, with interest rates remaining low and higher commodity prices boosting national incomes, bad debt charges are unlikely to trouble the sector in any major way.

But you’re not going to make a fortune investing in the banks. That’s a tortoise investment. These days, the hare is in the commodities sector. And with each boom, there is always a different sub-sector that is red hot.

My mate, Resource Speculator analyst Jason Stevenson, has uncovered some hot stocks in a hot sector. They are benefitting from the latest advance in technology. You can read about them in his special report, here.


Greg Canavan,
Editor, Money Morning

Editor’s Note: Could these three Gigastocks make you over a million dollars?

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Click here to discover ‘The Gigastock Phenomenon’ while you still can…

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

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