The market reaction to a small dip in the iron ore price last week suggests a degree of uncertainty among investors.
Iron ore has been very good for investors over the past few years, but like all good things in life it’s never wise to assume that it will continue forever; which is why another old favourite in the commodities world – copper – is seen as the next star.
The hiccup in the iron ore market last week when the price fell a modest 2 per cent to around $US130 a tonne caused near-panic trading in Australian iron ore miners.
Fortescue Metals Group, for example, lost 13 per cent. BC Iron lost 10 per cent and Atlas Iron lost 18 per cent – falls that not only outpaced the iron ore price decline, but also signalled that investors expect worse in the weeks ahead.
Lower iron ore prices are highly likely over the next 12 months if only because of the tried-and-true formula that what goes up must eventually come down. The only question is how far it will fall; and while a collapse to $US70/t (which one gloomy analyst at the investment bank UBS was tipping last year) now seems unlikely, a retreat towards $US110/t is possible.
What happens when (rather than if) the iron ore price slides back to a new, and more sustainable level, is interesting because it is possible that some of the better iron ore miners will be ‘oversold’, creating a buying opportunity.
Last week’s reaction to a 2 per cent iron ore price correction was the equivalent of ringing a warning bell to remind investors many people are keen to take their profits off the iron ore table because they’re aware of the ‘what-goes-up …’ rule of investing.
But even as the iron ore sector reacts to uncertainty about future prices there is an interesting new player in the commodity space, with early indications copper could be the hot metal over the next few years.
First hint that a copper revival might be under way came with news from Beijing that the China State Grid, the government agency overseeing the country’s electricity system and world’s biggest single consumer of copper, was planning a major expansion drive this year.
Like all Chinese statistics the numbers are huge and could be rubbery – a warning that what’s planned might not be what actually happens.
As a guide, however, the official spending plans call for $US63 billion to be invested in the national electricity grid this year, which is about 20 per cent more than 2013 and will include a 6 per cent higher demand for electricity-carrying cable (generally made of copper).
Some investment bankers have interpreted the electricity system expansion plans as a sign that copper, and copper miners, should outperform iron ore miners in the year ahead.
Macquarie Bank has calculated that the rate of growth for copper in China, driven by infrastructure spending, will comfortably outstrip the rate of growth in demand for steel, with overall copper demand rising by around 7 per cent while steel demand achieves a more modest 4 per cent rate of growth.
The question from the Chinese metal-demand numbers is whether the rise of copper and the slide of steel is a sign that it might be time to rotate investment funds out of Australian iron ore producers and into copper miners.
On current trends a switch might not be a bad strategy.
Bad auto loans
SUPER low interest rates continue to cause abnormal investor behaviour, making it a near certainty that someone is going to get burned by the latest fad – bundled sub-prime car loans.
If such an investment opportunity had been offered before 2007, no-one would have raised an eyebrow.
But after the Lehmann Brothers collapse, triggered in part by sub-prime home mortgages and resulting in the GFC, the words ‘sub’ and ‘prime’ have been off the radar screen of all sensible investors.
That’s not the case in the US, however, with people who might be called not-so-sensible investing in packaged deals containing car loans made to high risk borrowers.
The appeal of sub-prime car deals, which involves a bank pooling a large number of the loans into a single package, is the interest rate on offer; this can be as high as 12 per cent, because some of the loans made to questionable car buyers are being charged at 20 per cent.
The theory behind sub-prime car loans is exactly the same as sub-prime mortgages – the game is all about averages. If 10 per cent or 20 per cent of loans default, the rest of the performing loans make up for the loss.
It’s a system that works in good times when most borrowers do not default, but is a disaster in bad times when bad loans are made to people who cannot or will not pay.
The appeal in the US is that bank deposits are generating miniscule returns of 1 per cent, and less, which makes 12 per cent from a sub-prime package offered by a big name bank almost irresistible – or so it seems.
Gold woes over?
IT was interesting to read last week that Newcrest Mining, Australia’s biggest gold miner, believes it is “leaner and wiser” after a horror year.
As far as most outsiders can see, the only part of that claim is that Newcrest did indeed suffer a horror year, not that its shareholders need reminding after a 72 per cent fall in the company’s share price from a high of $24.77 to a low of $6.96.
Management, which has overseen some truly dreadful decisions, reckons that all the bad news is out; but that view does not seem to take into account two more possible downhill lurches for all gold miners.
Firstly, there are not many forecasters who can see the gold price rising over the next 12 months. Some even believe the price will slip towards the $US1,000 an ounce mark.
Secondly, the lower the gold price goes the bigger the asset-value write-downs that all gold miners will be forced to make by their auditors.
There might well be a light at the end of the tunnel for Newcrest, but investors would be wise to check that it’s not an oncoming train.
