kohler bear

From Alan Kohler - as an novice, I don't know about analysts, but this guy is really OK, and has some good ideas that most analysts don't seem to think about. In the brief article, Alan puts a macro picture spin that gives the breadth of understanding. Alan praises a Glen Lawcock - but as far as I know Glen and his team are still calling iron ore to bounce back at US$120/t - which is the same as FMG's forecast apparently???? In fact, one of the UBS analysts suggested on Thursday (on the ABC) is that it is because FMG use their research to base their iron ore forecasts!!!

In either case - I don't know and leave it to the experts – but worth a read.

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IRON ORE

Quite a few people would be watching the near vertical drop of the spot price of iron ore with a sinking feeling in their stomachs. This was not supposed to happen. Iron ore was supposed to stay above $110 a tonne, not fall below $90 like a hot knife through butter. Where will it end? And how will it play out?

Well, there is absolutely no reason for the price decline to end here, and there is no reason why the share prices of BHP Billiton, Rio Tinto, Fortescue and others can’t head a lot further south. In fact some of them won’t survive at all, which will eventually be very good for BHP and Rio. In particular there must be serious concern about Fortescue.

UBS’s excellent mining analyst, Glyn Lawcock, published a rundown of the various mining companies’ costs and margins this week, and the numbers for Fortescue look alarming.
With the spot price at US$93 (it’s now US$88, looking weak), Glyn estimated that Fortescue’s received price would be A$66 per tonne. That’s $11 per tonne less than the prices that BHP and Rio would get, because Fortescue’s ore has more moisture and less iron, which means the adjustment for freight, Fe content and moisture adds up to US$24 a tonne, bringing the price to Fortescue down to US$69, which converts to A$66.

Glyn estimates Fortescue’s cash costs at $52 per tonne and depreciation and amortisation at $5. Total costs: $57, cash margin: $14, compared to BHP’s cash margin of $40 per tonne and Rio’s of $47. Another $5 has now disappeared from all of those margins. At around $80 per tonne for iron ore, Fortescue is break-even on cash, and by the way Atlas, Mt Gibson and Grange Resources are all well underwater – losing heaps.

And also by the way, Gina Rinehart is looking a lot less rich than she was – about $9 billion – and facing a struggle to get the Roy Hill mine off the ground. In fact I would hazard a guess that, unless the price recovers there is no chance. That might give her more time to focus on Fairfax.

Anyway, it’s worth remembering that the iron ore price was around $50 a tonne in 2009 and while that correction was short-lived and was followed by a big rally to $170 by May 2010, there is a much more serious problem with steel prices this time. The UBS analysts expect prices to recover back to US$125 as a result of a “seasonal lift” in the fourth quarter. They point out that “there is no obvious failure in the industrial activity of Asia’s steel industry”.

That’s encouraging, but it’s also possible to see the iron ore correction as a part of a long cyclical turnaround of commodities in general.

During the week, Shane Oliver published an interesting look at the commodity price cycle, pointing out that the “pattern for raw material prices over the past century or so has seen roughly a 10 year secular or long term upswing followed by a 10 to 20 year secular bear market, which can sometimes just be a move to the side.” Between 2001 and 2008, the broad commodity price index went up 150%. It fell off a cliff in late 2008, of course, and then recovered with financial asset markets in 2009, but it’s clear that the bull market is over. At best it’s likely we’re looking at a period of flat prices, such as what occurred between 1955 and 1970, before the first oil shock got commodity prices, and inflation, moving again.
The upswing in commodity prices is usually caused by an increased in demand following a period of underinvestment in mining. The bear market is caused by the reverse: a big supply response to the increase in prices, and a macro-economic slowdown, partly in response to rising raw materials prices.

Global growth has now slowed and the only question about China is whether it’s a hard or soft landing. In iron ore as well as other commodities, there has been a solid supply response – in fact in Australia there is a once in a lifetime investment boom, although most of that is on LNG.