What’s the Verdict on Iron Ore Giants: Rio and BHP?

BHP Billiton Ltd

If you want to listen to Warren Buffett, be my guest. But ignoring macroeconomics and politics will break you not make you as a resource investor. This is why I provided a run down on the big picture for iron ore’s outlook yesterday…you can read it here.

Today, I’ll show you what a US$35 per tonne iron ore price means for all the miners this year. I’ll also give you details on a resource sector that offers huge profits ahead, both this year and next.

The short story is: If you want to make money in resources this year, keep reading. And if you don’t want to lose money this year, keep reading!

Ever since iron ore was trading around US$70 per tonne, I’ve strongly advocated Resource Speculator readers to sell the following iron ore juniors: Atlas Iron [ASX:AGO], Mount Gibson Iron [ASX:MGX], Fortescue Metals Group [ASX:FMG], and Grange Resources [ASX:GRR].

I copped significant reader criticism on my recommendation to sell Grange — one of the only profitable junior miners at the current lower prices. The fact is that iron ore is a dead sector with the spot price set to go lower. Good luck to any investors trying to make money in that environment.

Talking about a bleak macro outlook, you may have heard the news that Atlas Iron entered voluntary suspension and ceased production. Unfortunately for their investors, Atlas is unlikely to ever come out of its suspension — its debts are far too large and its cost of production too high.

Considering the horrible macro outlook, I even pulled the plug on Resource Speculator veteran BC Iron [ASX:BCI] before conditions deteriorated further. This was not a decision I enjoyed making. Although the share price is down a further 35% from where I sold it, and going even lower, readers copped an 85.7% loss.

Trying to see the positive side, this capital tax loss will be useful when my readers profit from buying the best gold miners…but only once the gold price bottoms at US$931 per ounce or lower this year. Looking at the macro playbook, gold is destined for lower prices once the Grexit is out of the way.

Looking at the negatives…I got iron ore wrong because I was too late in understanding the macro playbook — something that most ‘experts’ still can’t do. It’s not a good feeling that my mistake cost readers money. That said, I don’t plan on making this mistake again.

Learning from this mistake, I’ve explained in great detail the macro playbook timeline into 2016/17. My readers are now aware how stocks, bonds, emerging markets, currencies, and commodities will perform into the coming global sovereign debt defaults. And the coming period of rising geopolitical tensions and conflict.

Admit being wrong and learn from it

Coming back to iron ore, unfortunately, many other analysts, investment bankers, and research analysts got it wrong. But good luck trying to get them to admit it.

Last year, everyone wrong on iron ore was focussing on company financials and trends. Brokers will only downgrade their company share price forecasts after the sector destruction is felt. As we’re facing a significantly lower iron ore price, huge downgrades are to follow…

According to FNArena, investment banking and broker forecast consensus suggests that BHP Billiton [ASX:BHP] should be worth 10.6% more at $33.42, Rio Tinto [ASX:RIO] 23% higher at $68.72 per share, and Fortescue Metals Group [ASX:FMG] should be trading another 8.4% higher at $2.12 per share.

Hmmm, right…

If you don’t know, investment banking and broker revenue mainly comes from capital raisings, mergers and acquisitions, and trading (often with your money). In this case, with those forecasts, it’s clear that the big boys, and other brokers, don’t work for you. They’re ‘bearish’ and optimistic at the same time.

In my view, looking at the macro playbook, BHP’s share price should fall by 33% or more to $20 dollars this year. We’re likely to see Rio Tinto’s share price fall at least 30% to $40 dollars this year. And Fortescue could be smashed by as much as 50% this year…heading towards the $1 per share level.

Indeed, this straightforward forecast has everything to do with the iron ore price.

Going back in time, from the start of the resources super cycle back in 2003, prices have overwhelmingly been the major driver of earnings for both BHP Billiton and Rio Tinto. 76% of BHP’s core earnings growth (EBIT) was driven by higher prices from 2003 to 2014. Volumes contributed only 24% of growth.

In Rio’s case, prices contributed 72% of net profit after tax (NPAT) growth from 2002 to 2012. Volumes contributed a mere 28% of growth. (If you’re wondering, BHP uses EBIT due to accounting reporting differences.)

Price is the major factor to look at when investing in these big players.

As such, shouldn’t a falling Australian dollar benefit the local miners? Yes and no…

The Aussie dollar averaged 90 US cents over 2014. It now sits at close to 77 cents. This should give a considerable earnings boost to the major miners. However, the average spot price in 2014 was US$97 per tonne. It’s now roughly half that at US$50.80 per tonne…having bounced slightly in recent days due to the pull back in the US dollar.

Nonetheless, this price drop has more than wiped out any foreign exchange gain. Looking at the adjusted price numbers, the iron ore price was AU$107.77 per tonne in 2014 compared to AU$65.97 per tonne today.

Now consider the fact that Rio Tinto’s iron ore division generates 72.4% of the company’s core earnings. And BHP Billiton’s iron ore division generates 45.5% of its core earnings — a figure set to increase after the coming South 32 de-merger. It’s easy to see that iron ore is a huge part of the major players’ business earnings.

Yet, the share prices of the large miners have barely moved.

This is soon to change — big time!

Do you want to lose money or make money?

Both Rio and BHP have breakeven prices of roughly US$40 per tonne. Yesterday, I calculated that FMG’s breakeven price is US$49.11 per dry metric tonne — nearly US$10 dollars higher than the company will tell you. Given the macro environment outlook, how can the brokers’ forecasts be slightly correct?

We’ll soon see an iron ore price of US$35 per tonne…it’s just a matter of time. This will squash the big miners and send many of the juniors out of business.

I suggest removing the big miners from your portfolio whilst the opportunity is available. In fact, if you want to profit, going short may be the smart option…

With iron ore a dead dog, which commodities will make you money?

This is a question I’ve been contemplating for months.

But after researching every commodity you can think of (and many more you probably can’t), there’s one sector in particular that stands out the most. In fact, this commodity should be in a raging bull market from June this year. We’re getting closer to higher prices every day now…

That makes now the perfect time to buy into this sector.

It’s a ‘rare opportunity’. Events like this in the resources sector don’t come along very often…hence, the urgency to act now.

If you want to check out my research on this sector, click here. Most people are down on resource stocks right now, but as my report reveals, a brand new opportunity is about to emerge.

Jason Stevenson,
Resources Analyst, Resource Speculator

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

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