Why Fortescue Metals Group Fell 5% Wednesday

Iron ore miner Fortescue Metals Group [ASX:FMG] dropped 5.29% Wednesday morning, to $6.27 a share. The billion-dollar miner is still up 6.45% year-to-date, but that could change if the iron ore price continues to fall.

What happened to the Fortescue share price?

The iron ore price has been volatile in 2017. At the start of the year, the spot price climbed above US$94 a tonne. But it didn’t last long. Iron ore now trades around US$84 a tonne — including the 3% drop overnight.

Why did iron ore drop?

As reported by the Australian Financial Review:

Iron ore is getting battered. After rounds of warnings that this year’s rally may be overdone, the raw material is in retreat as doubts gather about the strength of demand in China as steel sells off and record port stockpiles put a spotlight on rising supplies.

What now for FMG shares?

This isn’t the news FMG wants to hear.

As an iron ore miner, FMG’s ability to earn profits is closely tied to the price of iron ore. If iron ore slumps due to excess supply, it doesn’t bode well for FMG’s profit margin. But if demand for iron ore picks up due to infrastructure spending increases, FMG’s profit margin would rise in tow.

Of course, there are other factors affecting FGM’s bottom line, such as competition and capital expenditure. But iron ore is the chief catalyst dictating earnings from year to year.

Macquarie Group Ltd [ASX:MQG] analyst Ian Roper said in an email to clients:

Steel demand in China is clearly robust, but iron ore prices remain very elevated versus fundamentals, and it’s only a matter of time before they normalise to below $US60.

We’ve had a negative view on prices for a while but they’ve held up longer than we expected.

This is a drawback to investing in commodity producers. Profits are more or less tied to the price of the commodity. Obviously, though, you’re not going to be complaining when commodity prices rocket up and resource stocks report earnings far higher than analysts expected. That’s what happened in 2016.

As for FMG, I believe the stock will remain volatile. The price of iron ore had shot up, and now it’s flagging. It will likely do more of this in 2017. As a result, you’re likely to see FMG’s stock price continue to swing.

If you can stomach the volatility, it might be worth looking at FMG for the long term.

Regards,

Härje Ronngard,

Junior Analyst, Money Morning

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