Things are just great — and that’s not just my opinion. The Australian Share Market just recorded its best quarter in more than five years. But looking at the headlines this morning you wouldn’t believe it. The news — being the news — is focussing on the negatives.
This morning Fairfax told us, ‘Aussie Shares Poised to Follow Iron Ore Lower‘. Sure, the market is lower this morning and the iron price dropped overnight. But I wouldn’t say the market is following the iron price. So far this year the iron price has been moving in the absolute opposite direction to the ASX.
Look past the fact that the iron ore price has fallen to a ten year low. Forget about the iron ore price all together — it’s not a sector you want to be in. Just avoid it. With a record quarter for the ASX, the wider market is clearly doing okay despite the iron ore price.
Falling Chinese growth is the main reason for the pain in the sector. Chinese industrial production was growing at 15% two years ago — this year that rate has fallen to just 7%. That said, China is now taking steps to support its economy. The central bank cut interest rates a month ago and this week they cut the minimum down payment needed for a second home from 60% to 40%. We’re yet to see if this will bump up growth.
A ramp up in production of iron ore by the world’s largest three producers — Rio Tinto, BHP Billiton, and Brazil’s Vale is also keeping iron ore prices down. In a reaction to low prices, they are upping supply to keep their profit margins high. The increased supply is pushing prices lower still and squeezing out smaller, higher cost producers from the market.
This increased production has seen exports to China hit record high levels despite its slowing economy and low prices received per tonne. All this supply combined with lower demand doesn’t bode well for the iron ore price.
However, iron ore is priced in US dollars. So you might think the 13% fall in the Australian dollar over the past six months would help out Australian iron ore producers — BHP Billiton, RIO Tinto, and Fortescue Metals being the big ones.
The problem is that the Aussie hasn’t fallen nearly enough to offset the fall in the iron ore price in that same time. US dollar iron ore has fallen from above $122 per tonne a year ago to around $60 per tonne today. And there’s no sign that it’s set to turnaround any time soon.
Fortescue Metals Group [ASX:FMG] has had a horror year. The stock lost two thirds of its value, and the rise in production by its larger competitors isn’t doing the group any favours. While the stock’s trading higher this morning, yesterday it closed well below a past support level of $2.00.
BHP and RIO, on the other hand, might be okay this year. And by okay, I mean not terrible. They’re better able to withstand lower prices as they ramp up production. Also, their share prices could be supported simply by the rush into the stock market as Australians search for better returns as interest rates fall.
An RBA interest rate cut next week, which is overwhelmingly expected, would bump up the market as a whole including our largest miners — BHP and RIO. This is exactly what we saw when the RBA cut rates back in February.
My colleague, Diggers & Drillers analyst Jason Stevenson, reckons that you’ll have a once in a lifetime opportunity to buy quality mining stocks this year, as he expects to see the bottom of the resources bear market. Jason says the commodities market is set to turn bullish in 2016.
That may be so, but I’d suggest you wait until signs of an improvement present themselves before jumping in just yet. Avoid the major miners — or any iron ore miners for that matter.
The market doesn’t have record setting quarters if something isn’t going up. So forget about the miners for now. There are plenty of opportunities out there. I’ve recommended some of the best opportunities in the Aussie (and overseas) markets in the Australian Investors Club. You check it out here.
Investment Director, Australian Investors Club