What if the Fallout in the Iron Ore Market is Only Just Beginning?
At a mining conference I went to last week, some of the company executives presenting looked pretty miserable.
A quick look at the company’s balance sheet explained the glum faces in most cases.
You could have drawn a pretty good chart showing the correlation between how much cash they have in the bank, and the executive’s demeanour.
The cashed up mining companies all appeared to be feeling pretty confident.
But it was a different story for those with ‘nought but a cracker’.
Unless these cash-strapped stocks had a half decent advanced project to their name, they knew it would be near impossible to raise money – certainly not while the overall mining sector is in such bad shape, at any rate.
This makes these companies’ life expectancy very short. In most cases, the company’s share price told the story. And just to rub the salt in, the low share price makes it even harder for these stocks to raise any kind of money.
It’s good to step back and remind ourselves just how far mining stocks have fallen in recent years. So this chart tracks the 38% drop in the metals and mining index (XMM) since its 2011 peak.
This has forced resource investors to adapt in the last few years. As editor of Diggers and Drillers, I have changed my strategy completely to make money in this kind of market.
The good news is that this chart is dominated by BHP (ASX: BHP) andRio (ASX:RIO), so is really a story about bulk commodities like iron ore. Iron ore has fallen off a 30% cliff in the last six months, and it looks like more pain is in store.
There are other commodities out there though.
You can still be a profitable resource investor – you just have to pick your corner of the market carefully. Adapting is more essential than ever.
For example, while iron ore has barely made a gain over the last three years, gold is up by 80%.
Looking ahead, iron ore’s fundamentals look horrendous, while gold’s have never looked better. Their respective charts tell the story. Iron ore is in sharp downtrend, while gold is in strong uptrend.
Gold still looks good after its run. For one thing, the fallout in the iron ore sector will send a lot of capital in the Australian market looking for a new home. Gold stocks will fit the bill, pushing gold stock prices up. Then the Federal Reserve’s latest round of money printing (QE3) will support a steady gold price rally as the months roll by.
Gold has long been a cornerstone strategy of my colleague Dan Denning’s The Denning Report, making up around 25% of the ideal portfolio. This has been a great strategy, but looks better than ever now. Dan even makes my recent gold price target of $3,200 look a bit lame, with his call for gold at $4,000 and beyond.
A combination of projects being shelved, job cuts at the likes of BHP andFortescue Metals (ASX:FMG), falling Chinese growth rates and stubbornly low Purchasing Managers’ Indices (49.9 today) mean that resource investors have to think differently from the pack today, and also be very nimble.
But are we just looking at the latest ‘dip’ in commodity prices and mining stocks?
Not according to Andy Xie, the contrarian economist who is calling for iron ore to halve from its current price to hit $50.
Xie is well respected and has made some unpopular, but accurate, calls over the years. He will be presenting at a conference I am speaking at in a few weeks time, and I look forward to having a yarn with him.
Iron ore at $50 may sound outrageous, but you only have to go back as far as 2007 to see iron ore at just $36.
If he is right, and iron ore falls back that far, the effect on the mining sector will be catastrophic.
More than ever you will want to make sure you are invested in the parts of the market that still work!
Dr. Alex Cowie
Editor, Diggers & Drillers
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