You Should Already Be Out of Iron Ore…

Loading of iron ore

Warren Buffett famously said, ‘Ignore politics and macroeconomics when picking stocks.’ This advice couldn’t be more wrong…

Ignoring macroeconomics and politics will break you, not make you, as a resource investor.

Today, I’m going to give you in-depth analysis on the iron ore sector. Resource Speculator readers received this analysis last week.

Resource Speculator focusses on helping you understand and profit from the real macroeconomic trends at play — the sovereign debt defaults of 2016/17, currency markets, and rising geopolitical risk.

If you want to be a successful resource investor, you must be able to connect the dots. From here, you can perform fundamental and technical research on companies within each sector.

But first, you must understand the big picture story…

Iron ore is in the doghouse. For months, starting when iron ore was above US$70 per tonne, I told my readers to expect a year-end iron ore price of US$50 dollars per tonne. It now looks as if this forecast may have been optimistic. We could see iron ore drop as low as US$35 dollar per tonne.

The current spot price of US$50.70 per tonne has already suffered from the US dollar bull and a supply glut coupled with a demand drag — factors that are all set to get much worse before they get better.

Hoping for Chinese stimulus isn’t a smart idea

The downward trend in Chinese steel consumption is highly concerning. China is the largest producer and consumer of steel in the world. India, a wild card in the commodities’ growth story, is still a number of years away from filling the demand and supply void. For this reason, you should ignore India when it comes to commodities for the time being.

The following graph indicates that Chinese steel consumption demand has peaked. In fact, the bar chart has petered off since mid 2013.

Steel demand growth in China has declined from 16% per annum a couple of years back to 3–4% today. At the same time, iron ore supply growth has doubled from 3% to 6% per year. As such, iron ore supply growth has more than doubled steel demand growth.

At the International Mining and Resource Conference last year, I spoke to Professor Li Xinchaung. Mr Xinchaung is the Deputy Head of the China Iron Ore and Steel Association. This is someone of supreme seniority in China — when he talks, people listen carefully.

Talking about the over development of 3rd and 4th tier Chinese cities, he said that there is still plenty of growth left in the Chinese property market. In fact, he said that Chinese steel demand should stay stable at 800 million tonnes per year for the next 10 years.

This is no surprise. The above graph indicates that this is exactly what China is consuming at the moment.

Now if you think the ‘coming’ Chinese stimulus package will change this scenario…think again! As a gentle reminder, Chinese Deputy Finance Minister Zhu Guangyao denied talks of any Chinese stimulus package inside last month’s China Securities Journal…calling the speculation ‘groundless’.

China has a debt problem. We’re more likely to see the People’s Bank of China cut its benchmark one-year loan rate from 5.35% to 0%. And cut the one-year deposit rate, from 2.5% to 0%. We’ll then see Chinese policy relax the quasi peg against the US dollar to assist its exporting sector. The US dollar is set to skyrocket to even higher highs into 2017 — this is a major investment risk for emerging markets and commodities.

That said, these moves will do very little for iron ore miners facing a flat demand curve. And if there is a stimulus package, review it at the time. You should never invest based on hope.

Importantly, the core issue with the iron ore price is on the supply side.

India won’t save you from the supply onslaught…yet

The graph below shows the iron ore supply expansion projects for all the major miners — BHP Billiton, Rio Tinto, Roy Hill, Vale, and many more. The vertical axis shows the tonnes, in millions, each project is set to bring online during that given year. The horizontal axis shows the year.

Source: RBC

Click to enlarge

Now this is just new supply from new projects. As you can see, the iron ore expansion is only one-third completed by the entire industry. Yet, the iron ore price stands at US$50.70 per tonne and will almost certainly dive lower. That said, an expected pullback in the US dollar may provide some breathing room…seeing a short term jump in the price.

Assuming Chinese steel demand stabilises at 800 million tonnes per year for the next 10 years (a 30% increase in total steel consumption), the price will continue to fall lower towards US$35 dollars per tonne this year. This is because demand will remain constant whilst supply expands rapidly.

In fact, there’s a risk that the iron ore price could decline below US$35 per tonne. There’s no doubt the future of many ASX iron ore juniors is in jeopardy. This includes Fortescue Metals Group [ASX:FMG].

The industry desperately needs India to come to the table. The new government already has huge infrastructure plans in place for the next five years. Indian Prime Minister Modi has pledged to develop multiple super highways, high-speed trains and construct 100 new cities focussed on specialised economic domains and ‘equipped with world class amenities’.

India is without a doubt the next China.

Adding to this, Modi wants to transform the country into a globally competitive manufacturing hub.

After decades of corruption and red tape, the country does have a long way to go. But certainly, Modi could be the man for this job. He’s already in the process of abolishing India’s planning commission — a useless and corrupt organisation that has led to a massive backlog of undeveloped projects.

The issues don’t stop here. Financing is another. Indian banks are sitting on US$22billion of infrastructure, construction, and iron and steel project loans — nearly 20% of these loans are non-performing.

Based on India’s business history and financial system, it’s going to be difficult for Modi to find the funds for development. Until this time, iron ore will continue to be in the doghouse.

Iron ore is one sector that won’t enjoy a return to the bull market in 2016 with many other commodities.

Which commodities WILL?

This is a question I’ve been busy working on the past few months.

What I’ve concluded is that there are three key sectors that should enjoy huge rebounds in the coming months. One has already started. And the stocks within those sectors are the ones you should back.

That said, there’s one in particular that I’m most excited about. In fact, a situation is emerging within this sector that has only occurred twice in the last 50 years. Each time, ‘pure play’ stocks in this resource have made almost unimaginable returns.

This is a perfect example of what I call the ‘hidden opportunities’ within the wider bear market. You can check out my research here.

The point is: Investment strategies based on hope aren’t an option or viable strategy in a resources bear market — they often end in tears and an empty wallet. You need to understand the macro playbook to find the companies worth your hard earned investment dollars.

You need to understand where to invest and where not to invest…when to invest and when not to invest. I’ll show you where, when and in what to invest in the days ahead.

I’ll start tomorrow with some fundamental analysis on whether you should buy, hold or sell the iron ore juniors and majors, BHP Billiton [ASX:BHP] and Rio Tinto [ASX:RIO], during this terrible iron ore period.

Don’t let iron ore get you down. There’s a massive emerging opportunity in the resources sector. In fact, two major factors affecting the macroeconomic and geopolitical space should start to converge in June 2015. Don’t let this opportunity slip past — now is the time to get in…You can read about it here.


Jason Stevenson,
Resources Analyst, Resource Speculator

Editor’s Note: This article originally appeared in Money Morning.

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