On 22 September back in 1981, a financial editor at the UK Guardian introduced to the investing world the graphic metaphor “dead cat bounce.” That morbid image referred to an illusory uptick in price of a particular stock or market sector following a calamitous fall. The obvious point is that the still dead cat will eventually return to earth.
Given the fact iron ore remains Australia’s “bread and butter” export, the investment community is and should be concerned about the sustainability of the remarkable rally in the price of iron ore.
A 23 April article in the Sydney Morning Herald told us UBS had just downgraded shares of our largest iron ore miner BHP Billiton (BHP), claiming the iron ore rally was not sustainable.
On 29 May an article appearing in business insider Australia told us Morgan Stanley commodities strategists are of the opinion prices are “now starting to approach peak levels,” forecasting a drop for the price of 62% fines to $78 by year-end.
On 14 June the price hit a five-year high of $USD110.20 on the IODEX (SPGlobal’s iron ore index) or IODEX. Year to-date the price of iron ore is up 51.5%.
At the close of trading year 2015 the price dropped below $USD40 per tonne, with some analysts speculating the days of $100 pricing could be gone forever. Few, if any, foresaw what a difference a few years and supply concerns would make.
While no one is yet referring to the current rally as a dead cat bounce, given the crisis in Vale’s mining operations and devastating cyclones here, as far back as 2012 numerous articles were trotting out the dead cat bounce in the face of rallies in iron ore pricing. Here are the dates and sources of some of them:
Those who cry beware the dead cat bounce are warning investors that a rally following a steep decline may soon be followed by another decline, eclipsing the original decline.
But the five-year price chart for iron ore seems to show the dead cats continuing to bounce and bouncing higher than their initial fall.
Over ten years the picture would be similar but not as clear cut as the massive mining boom spurred by China’s incessant infrastructure building pushed the price of iron ore to $180, with investors assuming the collapse in the price would lead to an equally disastrous collapse in the share price of our major iron ore miners. The following five-year price movement chart from au.yahoo.finance.com for the top miners by market cap on the ASX also shows a pattern of falls and recoveries from 2016 onward.
The advice to “beware the falling knife” or the “dead cat bounce” has merit, but in many situations, it is short term in nature. There are those market purists who draw a distinction between investing and trading, with the key difference being the time the stock is held. Traders look for profit in the short term while investors are willing to wait for long term gains.
The distinction is not always clear in financial articles, suggesting the “dead cat bounce” advice may be more for short-term traders rather than long-term investors. The following table of historical performance for the four top ASX miners investors were warned to avoid support that case.
As the trading year 2019 began BHP Group Limited (BHP) had the distinction of being Australia’s largest company, with fellow diversified miner Rio Tinto Limited (RIO) ranked third. Although both rely heavily on iron ore, they have other operations that in boom times can have the effect of diluting the rising tide in iron ore.
Some analysts and experts caution investors about “one trick ponies”, or companies with a single revenue source. However, pure plays in a hot sector refute that claim. It is somewhat of a surprise that over a volatile period a pure-play iron ore miner like Fortescue Metals Limited (FMG) has outperformed its larger rivals in virtually every performance measure in our table. The company’s dividend performance remains unmatched, with a $0.60 per share dividend paid on 14 June, bumping its dividend yield 7.2%, while BHP’s most recent yield was %5.3% and Rio’s was 5.2%
Fortescue, however, has not found favor amongst the analyst and expert community with its frequent huge debt loads. The company’s current gearing is a little over 40%, comparing favorably to BHP’s 48.3% and Rio’s 26%.
The company operates three operating mines in the Pilbara region in Western Australia, with a major competitive advantage through its wholly owned mining infrastructure, including rail transport and port facilities as well as a fleet of iron ore carriers.
Fortescue is ready to battle its reputation as a lower ore grade producer with its $AUD3.6 billion-dollar investment in a higher-grade magnetite mine at Iron Bridge. This follows the company’s decision to build another hematite mine – Eliwana — incorporating the latest in mining technology. Magnetite iron ore requires further processing prior to shipping, making it more costly to produce but its higher grade versus hematite comes with premium pricing.
Fortescue’s principal export destination is China, making the company vulnerable to shifting demand there as well as to major fluctuations in the price of iron ore.
BHP has the benefit of diversification, branding itself not as a mining company but as a “global resource” company, with operations spanning iron ore, copper, coal, nickel, and potash along with energy assets in oil fields here in Australia and in the US region of the Gulf of Mexico.
On paper diversification into related asset classes reduces risk, but poorly planned or executed acquisitions can and often do prove costly. BHP’s potash venture into Canada has yet to pay off and its disastrous attempt to profit from the US shale oil revolution ended in BHP selling for a loss the US shale assets it paid so dearly for.
Rio has shed itself of all coal assets and now operates four product groups –aluminium, copper & diamonds, energy &minerals, and iron ore. The company’s energy and minerals group operate borate, sea salt, and titanium dioxide along with uranium mining operations in Australia and Africa and a uranium project under development in Canada.
Rio has grown both revenue and profit in each of the last three fiscal years, with revenue rising 23% over the period while profit was up 77%.
Mount Gibson Iron (MGX), based in Western Australian, began in 1996 and listed on the ASX in 2002, opening its first mine to commercial production – Tallering Peak – in 2003, still in operation. In 2007 the company acquired Aztec Resources, with its Kooland Island mine. A collapsing sea wall forced the company to close the mine in 2014. Mount Gibson is now rebuilding the mine, planning to resume production of high-grade direct shipping ore (DSO) in late 2019. The company had another DSO operation at Extension Hill/Iron Hill where the production at Extension was phased out in favor of Iron Hill with production at Iron Hill to cease and following shipping of remaining stock in storage both site will go into closure.
The company had solid financial performance between FY 2017 and FY 2018 following a disappointing FY 2016. Revenues were up 37% while profit rose a stunning 281%.
The company has been a favorite of investors, with the trend continuing with a Half Year 2019 financial report that saw a tripling of net profit and positive guidance for the upcoming commencement of mining operations at Kooland Island.
There is an “under the radar” pure play iron ore miner that bears mentioning. The company is Champion Iron Limited (CIA), coming on the ASX in 2014 following a reverse merger. Champion is based in Canada with assets in the Canadian equivalent of our Pilbara mining region – the southern Labrador Trough, which extends through the Province of Quebec into the Labrador region of the Province of Newfoundland.
The company has eight projects under development, with existing infrastructure facilities near the mining projects and shipping terminals in place on the Gulf of St. Lawrence.
Although Champion is thinly traded, with a 30-day average volume of less that 500 thousand shares, its market cap is a hefty $1.4b. The company’s two-year earnings growth forecast is +109% and the share price is up 125% year over year and close to 700% since listing on the ASX.
The US/China trade war may have a beneficial impact on ASX iron ore miners. In 2008 the Chinese government responded to the GFC with a massive building programme. It now appears the Chinese may be about to repeat that strategy in the face of an economy weakened by the trade war.