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 https://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.)
southof8
Fortesque Minerals (FSUMF) have just announced a profit of AUD$780 million (working from memory here so that is approximate) and announced that they were using the profits to push ahead with the Christmas Creek mine development ( 70 – 80 km east of Cloudbreak mine). I worked on the original rail development and until recently held shares in the company. Reading between the lines that sum, on top of what has already been spent on the development, will be close to being sufficient to finish the development. In that case one can expect production to increase significantly in 8 to 12 months time. Although I would not expect much of an increase to the bottom line until the following year. Fortesque also has the Solomon prospect which is several hundred km west of the Cloud Break mine (Tom Price / Pannawonica area) and is trying to get access to Rio Tintos Port / Rail infrastructure. Rio Tinto has 2 Ports in the Pilbara region Dampier (15 km west of Karratha) and Cape Lambert (30 km east of Karratha). Cape Lambert is due to start the Port B expansion late this year. This will include a second 4 berth ship loading facility and a second Ore Stockpile / yard area with associated train unloading facilities. The expansion should double the capacity at Cape Lambert. Incidently, I work for Rio Tinto at Cape Lambert
Whether or not Fortesque get access to Port / rail facilities is an open question, Rio are resisting this quite strongly and will only concede access if required to by the courts.
Jim,
could you post an article about coal ash. I’ve seen 2 reports on coal ash and on was talking about the lake I grew up on. Duke Energy owns that lake.
http://www.charlotteobserver.com/2009/12/04/1090055/duke-energys-piled-up-coal-ash.html
I have a question for Jim or anyone else knowledgable in this space and the effect of the change on contract pricing.
If I remember correctly, FSUMF adhered to the outdated contract price model even after the last annual price contract expired, probably because it had greater need for predictable cash flows to pay its enormous debt incurred to build out its infrastructure (and was sucking up to Chinese customers hoping for favorable financing).
THis continued even after VALE and BHP and RTP started pricing at the spot market, costing FSUMF a pretty penny in revenues had they joined the party (which party led to, among other things, a breakdown in civility among negotiators, evenutally resulting in the BHP exec getting jailed and tossed off the back of the wagon by BHP management when the Kangaroo court in China convicted him. Wonder if the Saskatchewan government was paying attention? But I digress).
As Jim notes in this post, the annual contract pricing model has gone by the wayside. Does this mean FSUMF now prices according to the quarterly contract model, which is itself based on the spot prices? Moreover, does this mean FSUMF can look forward to greater revenue growth and margin expansion, all other things being equal, than its larger competitors who made the change earlier (and got the revenue spike last year as a result)?
That seems logical to me, but I really know very little about this industry and space.
Anyone have any thoughts? FSUMF has been running a bit lately, but it’s difficult (for me anyways) to find any information on the company.
I will be watching, but I hope you will remind us when might be a good time to buy .