China Can’t Afford to Pick a Fight

China Can’t Afford to Pick a Fight

Dear Reader,

Out of all the Aussie stocks to be holding right now, which ones should they be?

My first answer would be a gold producer or two that is pouring gold for less than $1,500 an ounce. But then given my gig over here, I’m possibly a little biased towards gold…

In this current environment, I’d say don’t bother with childcare companies for now. The ‘free’ government childcare package is actually hurting their profits.

And despite my ability to buy shoes through a pandemic, there aren’t many discretionary retailers I’d suggest either.

However, you’d probably want to look at a defence stock or two.

These extraordinary times means it’s likely non-government, military-type companies will get some government coin. If you’re looking for some sort of long-term telco play, a subsea cable or satellite company would get my vote.

What about minerals, the stuff Australia is famous for?

And alongside the banks, the other asset making up a disproportionate value of the Australian Securities Exchange (ASX) is resources.

Well, there’s a global shortage of quarry materials. Given some sort of stimulus package from the government will likely involve infrastructure, I’d be looking at miners of sand, gravel, and basalt.

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Then we have iron ore.

One of the critical swing factors for the Aussie dollar…

Three of Australia’s largest mining companies pretty much have just one customer.

A customer that’s in the process of picking a fight with us…

Are they the stocks you should be holding?

They’re stuck with us

If you’re holding the trio of Aussie iron ore stocks, chances are you get a little jittery every time the Chinese Communist Party (CCP) mentions they could go ‘elsewhere’ for what they need.

No stocks more than Rio Tinto, BHP, and Fortescue Metals Group are exposed to fall out with Beijing powers.

While they’ve spent a couple of years attempting to diversify, both Rio and BHP still have more than 50% of their assets in iron ore.

So, despite having a few other minerals under their belt for sale to a handful of other customers around the world, their predominate business is selling red rocks to China.

No one is more connected to iron ore and China, than FMG.

Despite the increasing tough talk and finger-wagging from China, both Rio and BHP share prices have recovered a little more than half their losses since the March crash.

FMG on the other hand, is sitting at an all-time high of $14.71. Up a massive 78% since the March low.

The problem is, a punt on these stocks is as much a punt on the iron ore threat between us and the Middle Kingdom holding.

How is that possible and why would people still want to own stocks so closely correlated with drama?

Simply put, the CCP have a problem.

And for now, Australia is the only one that can solve it.

Beijing authorities may have shut down more than 80% of their economy in February. Yet somehow they’ve come out the closure and iron ore demand is increasing. Part of it is tipped to refilling stockpiles. The other part of the demand is suspected to be ‘hope’ that when the world economy starts again, China will have what we need.

Meaning for now Chinese companies are forced to buy from us whether they like it or not.

In fact, it could be months before they have the chance to ditch us…

Brazil can’t compete…for now

Let me take you back to January last year.

A time before we knew of this thing called social distancing.

A time when the federal government was promising Australia a surplus.

Yet it was 16 months ago that a dam wall collapsed at the Córrego do Feijão iron ore mine owned by Brazilian company Vale SA [NYSE:VALE]. Taking out 5% of the world’s iron ore supply with it.

That tragic collapse boosted our fortunes.

It drove the iron ore price higher…which drove the Aussie dollar higher…which drove the share prices of Rio and BHP higher…

With a large percentage of the world’s iron ore offline, Australia benefitted from it. Even before COVID-19, when Vale roared back to life, all three were tipped to fall.

But when Vale did reopen, flooding and bad weather meant that they couldn’t even get the mine going until March this year.

As the coronavirus made its way around the world and finally reached Brazil, many mines were forced to close by government decree. That meant the barely reopened Vale, was closed once again.

Only now is the Vale mine online, and it’s still struggling to get back to full production.

In 2019 the mine would normally send 6.5 million tonnes of iron ore per week to China. For the first three weeks of May this year, barely 4.5 million tonnes were loaded into shipping containers each week.

Word has it the virus is crippling regional staff meaning that production can’t meet the CCP’s expectations.

To boot, many other global miners have all been forced to close. South Africa, India, and Russia have all seen their iron ore miners shut down because the government has said so.

Meaning right now, the CCP have no other country that can ship them the iron ore they demand.

How long will it last?

Of course, how long our iron ore dominance lasts remains to be seen.

Given that so much of the global supply has been taken offline, there are few countries that could match us even before the virus shut down economies.

More to the point, bringing supply back to what it was is no easy task. Mine sites aren’t like turning on a light switch…

That means for Aussies, iron ore prices are likely to remain higher for a few more months yet. Meaning our trio that deal in red dirt probably have some more gains to come.

Despite the increasing geopolitical tensions and threatening to go elsewhere, the CCP don’t have a choice.

Beijing authorities are stuck with our iron ore until a bigger supplier comes along.

That means for now, RIO, BHP, and FMG are probably going to go even higher for longer — despite the war of words from the powers that be in Beijing.

Of course, there’s a couple of factors that are likely to bring this trio back down. And I’ll dig into those on Thursday.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

PS: Market expert Shae Russell predicts five knock-on effects of the recent market crash that could be even bigger threats to the average investor’s wealth than the crash itself.