iron ore article

Iron ore’s hotter prospects
By Tim Treadgold



PORTFOLIO POINT: It helps to consider the logistics of iron ore mining when choosing between the juniors.


There’s no shortage of iron ore in the world, but there is a shortage of railways and ports.

It's that capacity shortage latecomers should consider if joining Australia’s great iron ore party, which has sent some stocks such as Fortescue Metals Group and Portman Mining into orbit while contributing greatly to powerful price increases in leading resource stocks such as BHP Billiton and Rio Tinto.

Separating a very crowded house into its component parts of good, bad and ugly is essential for successfully playing the hottest game in the resources sector. And it's not too late! However, if you are hunting for iron stocks with “big” potential the sector, those with latent appeal must be the “mid cap” miners – stocks such FerrAus, Iron Ore Holdings, BC Iron, Territory Iron and Centrex Metals.

To understand why railways and ports are so important, consider first the nature of iron ore: a relatively low-value “bulk” commodity that is traded in millions of tonnes, not kilograms or grams.

Then ask yourself three questions:

1: Has your preferred iron ore investment got any hope of ever getting a tonne of iron ore to a port, let alone taking the next critical step and get it on to a ship? In most cases the answer is no, so think again.

2: Is your preferred iron ore investment proposing to mine haematite, or some other high-grade material grading more than 55% iron (as is held by BHP and Rio) or a low-grade ore such as magnetite which grades around 33% iron (as makes up much of reserves held by “hot” junior Gindalbie Metals)? If it’s haematite, proceed. If it’s magnetite, take care because the essential upgrading before shipping adds to the cost and risk.

3: Will your preferred investment become a takeover target in the consolidation phase of the iron ore sector that has just started? If the answer is yes, proceed with caution for what might be a big payday.

In the last iron ore boom during the 1960s, when BHP Billiton and Rio Tinto carved out the best deposits for themselves in the Pilbara, about 1500 kilometres north of Perth, the iron ore business model had nothing whatever to do with finding or mining.

Iron ore was, and remains, a game called “transport economics” because the world, the planet on which we live, is more than one-third iron. The scientific measure for curious readers is that 34.6% of the world is iron, comfortably ahead of oxygen (29.5%) and silica (15.2%).

Most investors can forget those measurements, but should never forget that there is an awful lot of iron ore looking for a market, and high prices always trigger a development boom, almost certainly leading to over-development.

That’s why Fortescue’s charismatic boss, Andrew Forrest, continues to fight for access to the railway system of BHP Billiton, and why another iron ore billionaire, Hamersley heiress Gina Rinehart, has teamed up with Rio Tinto to develop her first mine at Hope Downs.

The Rinehart experience is sobering. Her father, the late Lang Hanc-ck, played a pivotal role in the early stages of the Australian iron ore industry. But, Hanc-ck never developed a mine of his own despite controlling some of the best deposits in the Pilbara.

In fact, Hanc-ck spent a lot of his time designing railway systems and ports, including one famous plan to use a nuclear bomb to create a deep harbour on the Pilbara coast. The “father” of the hydrogen bomb, Dr Edward Teller, was once a consultant to Hanc-ck on the harbour plan at Cape Keraudren.

This is an extreme example of how critically important railways and big ports are to iron ore, and why some of the smaller players in the game today using trucks and small ports to get their cargo to market will not survive any future downturn in the price of iron ore – which will come because of the first factor in the equation – there is no shortage of iron.

Company promoters are claiming that this time the game is different. They point to:

Surging Chinese demand for steel, and predictions of another big rise in the price of iron ore later this year.
The development of new iron ore provinces, such as the Mid West region of WA.
The advent of the magnetite era.
That remote iron ore deposits in central Africa will yield a quick return.

On those claims the touts are almost certainly wrong.

First, there is nothing new about mining for iron ore in the region known as “Mid West” in WA – the area where the iron ore boom is actually taking place. Mid West was the site of one of Australia’s first iron ore export adventures in 1964 when Western Mining Corporation (now part of BHP Billiton) shipped material mined at Tallering Peak to Japan via the port of Geraldton.

Today, there is a scramble for access to Mid West iron ore, including the takeover bid launched last week by Murchison Metals for Midwest Corporation.

More takeovers in the region will follow, largely because there are so many small players in the Mid West region and the adjoining, but remote reaches of the Yilgarn region where transport distances stretch out to 1000 kilometres and more.

Distance is the first critical point in this exercise in picking potential winners, plus the fact that there is no viable railway system in the Mid West. A track once ran all the way to Wiluna, but was pulled up decades ago. Also, there is no big export port on the coast, just the relatively small port of Geraldton which can handle only modest cargoes.

To fully capitalise on the Mid West iron ore deposits, which are sub-standard when compared with the Pilbara, a new railway is required, and a new port. For those assets, add about five years to your investment equation, and factor in a series of environmental, and other government approval, hurdles.

And what of the magnetite boom promised by companies such as Cape Lambert (CFE), Australasian (ARH), Grange (GRR) and Gindalbie (GBG)?

It is possible that WA will see a magnetite boom. But, that possibility is in the same category as the promised 1960s steel-mill boom on the west coast (failed), aluminium smelter boom (failed), petrochemical boom (failed), value-added iron ore processing boom such as BHP Billiton’s $3 billion hot briquetted iron plant at Port Hedland (failed), and a paper-pulp boom (failed).

Magnetite is an ore of iron best suited for short haul transport to a steel mill. It’s the stuff now being used by OneSteel at Whyalla in South Australia after it decided to export its reserves of haematite – the ore best suited to long-haul transport because of its higher grade.

To be exported, magnetite must have its waste material (such as silica) removed and lifted from its average of 33% to 65% or more. That requires a major investment, and that’s why BHP Billiton and Rio Tinto have not gone down the magnetite road, and why they are pouring billions of dollars into expanding their haematite mines, railways and ports.

There is also a new factor in the magnetite equation: the US sub-prime credit crisis, which is making it harder to raise big dollops of debt for resource projects.

As for companies with remote deposits in central Africa, these might be winners one day, but that day is a very long way off, and will require the building or ports and railways, and raising large amounts of debt in a world becoming more risk-averse.

For most investors the best policy will be to focus on the basics in Australia. Top of the list should be mid-cap haematite miners positioned between high-risk micro-caps and big-cap stocks that all the world knows already.

Here's my list

FerrAus (FRS), a low-key explorer with its foot on a potential major development in the heart of Western Australia’s iron ore country, the Pilbara.
Iron Ore Holdings (IOH), a market darling in late 2005 which fell from grace but which has an excellent tenement position in the Pilbara and has recently attracted the eye (and cash) of one of Australia’s richest men, Kerry Stokes.
BC Iron (BCI), named after Bonnie Creek in the Pilbara and a company with an extensive asset base, and a near-certain takeover target once the battle for Consolidated Minerals (which owns 27.7% of BCI) settles.
Territory Iron (TTY), a new exporter in the Northern Territory, which made its first shipment of iron ore from Darwin last month and which will almost certainly launch itself on an aggressive acquisition trail.
Centrex Metals, a wildcard in the iron ore pack with its foot on high-grade iron ore on South Australia’s Eyre Peninsula, and now looking for an export port.

Each of the stocks mentioned has attracted some interest on the market, but has not delivered the 10-times return seen in FMG over the past two years as it has rushed from $5 to $50.

FerrAus is up from a 12-month low of 34¢ to recent trades at $1.12. Iron Ore Holdings is up from 39¢ to 77¢. BC Iron has risen from 43¢ to $1.70. Territory is up from 59¢ to $1.10, and Centrex has risen from 14¢ to 49¢.

Despite their different locations (three in WA, one in the NT and one in SA) there are common threads linking the five stocks mentioned. Each is looking to mine or (in the case of Territory) has started mining high-grade iron ore, and each is close to a rail system, or a port.

For the best and fastest returns, stick to companies such as those mentioned above, and even consider some that have already risen strongly, such as Atlas Iron (AGO), which has a haematite deposit (plus magnetite) is close to Port Hedland and has a development agreement with FMG. It might also represent a tasty takeover morsel for FMG once it starts exporting in the middle of next year.


Territory certainly fits all the requirements and is producing now.Dilution of shares with the SPP is only good if the monies raised are used cost effectively. M.K. does not waste time sitting on his hands.The revenue from the shipments is beggining but not quickly enough at the moment to take this company where M.K. wants to go with it.
RAB



















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