17% fall points to iron winter and M&A for pure plays

Talking about the Iron Price.

In May we chatted about the monthly change in the RBA’s spot price index for bulk commodities (predominantly iron ore and coal).

I noted the rate of change in the index was back on the up at 5%, but that an iron winter might be coming.

Here’s that first chart.

Spot peaked in May after the index indicate 12% growth.

In June it started to fall with price index growth slowing to 11%.

Then in August, I wrote again after we witnessed another slowing from 11% to 4%.

Here’s that July chart published in August.

Thoughts at the time.

In August, I suggested that short term, if the trend was to continue there would probably be another month of slowing but potentially still above o% which would still point to growth.

Well, it certainly slowed and kept going well below zero, to negative 17%!

What does this tell us about paying the iron price?

Index rate of change in the three month period May to August 2021 indicates lower highs and lower lows than the three month period comprising December 2020 to March 2021.

This is a strong confirmatory signal to the bottom right for iron prices at a time when Delta is on the increase and Brazil supply is still constrained.

But let’s also remember that index weightings for iron ore (31.5%) and coal (21.7%) make up 53% of the index, with LNG making up 17%.

That means our three key exports to China, South Korea, Japan, etc., make up over 70% of the index.

We also know that:

• Coal prices have been going up markedly.

• Since April, LNG prices have also been on a tear.

• Each of aluminium, nickel and gold (which make up a further 10% of the index bringing the total to 80%) were also up on July prices.

That leaves iron ore as the anchor and it means that it’s fall was greater than 17%.

Reasons? COVID and slowing global growth. China iron ore stockpiles a false lead indicator in light of ‘steel production versus clear skies’ tug-of-war. Geo-political manoeuvring between China and Australia (and others). Competitive responses between producers and specific steel mills.

With all commodities, there will always be cyclical up and down drafts caused by supply and demand factors at the time, plus government policy.

But the overall secular of slowing growth plus China accelerating its own-sourced/owned material, makes this look like the start of another iron winter.

To summarise, the last six months indicates a trend of lower highs and lower lows, and a potential movement towards mean reversion for iron ore, if slowing growth continues with some help from Delta and other pandemic ripple effects.

What now?

Well, despite its major shareholder saying otherwise last week, Fortescue Metals Group (ASX:FMG) still looks like an iron ore company to me.

To change, it’s going to need to undertake M&A and/or asset transactions that move it into the more fashionable minerals/applications, at a scale that can move the dial for a $57 billion capitalised pure play - because other methods will take too long.

As the race to diversify continues amongst the big end of town, value will start to rotate into other areas.

But the rotation in and out of specific metals is fickle. There has never been a time when so many different secular forces have impacted markets at the same time, causing one metal to react in a very different manner to the next.

See you in the metals markets, but only some.

Mike.

Next Level Corporate Advisory is a leading M&A and capital markets advisory with a multi-decade track record of delivering high quality independent financial advice and crafting strategic transactions, to help clients level-up.

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