It’s hard to imagine this happening with any other “product.”
The price of the product drops 12% for the next quarter.
And the stock market essentially shrugs it off. On a bad day for the market, August 30, when the Standard & Poor’s 500 stock index drops by 1.47%, the shares of the world’s biggest producer of this product fall by 1.29%. Shares of the second largest producer fall by 2.49%, it’s true, but that’s not unexpected since the beta of that stock (the measure of the stock’s volatility in comparison to the entire stock market) says that these shares are on average two-thirds more volatile that the stock market as a whole. (The drop in the shares is almost exactly what beta projects.)
And on a good day for the market, September 1, when the S&P 500 jumps by 3%, shares of the largest producer rocket upward by 5.5% and shares of No. 2 go up 6.1%
Guess when it comes to iron ore—and that’s the “product” in question—investors just don’t expect any price drop to last for very long.
Even after the drop iron ore prices would be120% higher than they were a year ago. So this disappointment would leave these miners still incredibly profitable.
Iron ore prices, which used to be set by annual contract negotiations, are now set quarterly by reference to the price of iron ore on the spot market. The new quarterly price set on September 1 dropped by 12% to $128.50-$130.00 a metric ton from $145.00-$147.50 in the current quarter.
The old investing adage—Acorns don’t grow to the sky—seems apt here. After more than doubling in a year, it’s only reasonable to expect prices to pull back a bit. The cause of the price drop is a temporary glut in steel that is reducing demand for both iron ore and coking coal.
But judging from the very modest decline (first) and then the huge rally (second) in the shares of BHP Billiton (BHP), the world’s largest iron ore producer, and Vale (VALE), the world’s second largest producer, no one expects that steel glut or the decline in iron ore prices to last for very long.
Frankly, I’d use any weakness in the sector in the next quarter on this price decline to pick up shares of iron ore and metallurgical coal miners. I mentioned three coal producers in my post http://jubakpicks.com/2010/08/27/acquisition-fever-burns-hot-here-are-three-stocks-to-profit-from-the-frenzy/ that would deserve a look in that scenario. (And it doesn’t hurt that they’re all potential acquisition candidates too.)