The Iron Ore Price and Why Twiggy Has Snapped

Here’s a tip for you. When the massive iron ore price bust turns Fortescue Metals Group Ltd [ASX:FMG] boss Twiggy Forrest into a minority owner and depletes his wealth, he’ll go into politics.

His performance over the past week or so has been masterful. That’s if you look at it from a political perspective. If you view it through the lens of capitalism or economics, his behaviour is a disgrace.

When the iron ore price was in a credit bubble induced mega boom, the iron ore was ‘his’. Now that it’s in the bust phase, the iron ore is, apparently, ‘ours’. What a bunch of self-serving gibberish.

Forrest has single-handedly managed to convince the government of the need to hold an inquiry into the behaviour of the mining giants, BHP and RIO, and their effect on the iron ore price. And the clowns in parliament look like they’re falling for it.

Never mind that the behaviour of BHP and RIO is a case of textbook economics. That is, when you’re a commodity producer, you produce as much as you can at the lowest possible cost.

And if you’ve got the best deposits in the world, a by-product of that strategy is that you lower the marginal cost of production across the industry, putting pressure on other, higher cost producers.

The iron ore price is simply reverting to its long term average. That means all the juniors who entered the market based on boom time prices will eventually fall by the wayside. Fortescue will probably survive, but not without selling a large chunk of itself to the Chinese in the years to come as it tries to recapitalise and lower its massive debt levels.

This is just run-of-the-mill economics. Yet Forrest has managed to convince the idiots in Canberra that something needs to be done. It is absolutely astounding, to me at least, that anyone is even entertaining his self-serving rhetoric. It just goes to show that Australia is now under the control of rent-seekers everywhere.

Forrest’s argument is that a higher iron ore price means more tax revenue for governments and more spending on ‘schools, hospitals and roads’.

Never mind that previous governments blew the past commodities windfall by making things like pensions, superannuation and middle class welfare more generous, concessions they now find almost impossible to claw back.

More hospitals? Yeah, right.

Yet we’re now pandering to Twiggy because he so passionately believes in the tax and welfare generating abilities of ‘our’ iron ore industry. Yet as I recall, he was vehemently opposed to the Minerals Resource Rent Tax when it was first proposed. This was an attempt to better share the profits of ‘our’ resources, a more efficient tax than the current royalty system. Back then Twiggy called it ‘economic vandalism’.

But double standards are the hallmarks of the rent seeker. Unfortunately, Australia is swarming with them…

As I try to get the dirty taste of it all from my mouth, let’s turn to the market.

An important shift seems to be underway. Yesterday, the broader market struggled as last week’s banking sector rebound came to an end. All of the major banks except National Australia Bank [ASX:NAB] ended the day down 2% or more.

Westpac [ASX:WBC] in particular looks vulnerable. Since the start of April, its share price has gone from $40 to around $32.20. That’s a fall of nearly 20%. There goes the dividend yield…for about four years…

Westpac’s share price is now back where it was at the end of 2014. On the surface it looks like reasonable value again. It trades on a price-to-earnings multiple of 13.1 times expected 2015 earnings. The dividend yield is a healthy 5.82%.

This should support the share price around current levels. But the bigger question is, are the days of growth over for the banking sector?

It’s too soon to tell for sure, but judging from the recent performance of the banking stocks, you could certainly argue that is the case. This is especially so because the recent sell-off occurred while the RBA cut official interest rates to a record low.

I wrote about the response to this in the latest issue of Sound Money. Sound Investments (SMSI):

Some of the banks didn’t pass on the full rate cut. This tells you they are concerned about credit quality and maintaining their margins. As the RBA goes further into record low rate territory, it will get less bang for its buck.

This is why I think we’re at some kind of an inflection point. What used to work isn’t so much of an easy bet now. As a result, you’re going to see investors increasingly shift capital from the banks and financials into the more overlooked parts of the market.

It will trigger a search for value as investors realise the banks have already seen their best days in terms of profit growth.

That’s what you’re seeing now. Investors increasingly see the banks are ‘ex-growth’. As a result, capital is looking around for the next opportunity. I’ve been focusing on this ‘next opportunity’ for my subscribers over the past few months.

Despite the fact that the market is expensive, there are still pockets of value around. I consider the gold sector to be one such ‘value play’ but the high potential rewards obviously come with a lot of risk.

There is another sector (with lower risk) that I think could be the recipient of investor capital looking for value in the months ahead. I’ve made a few recommendations in this sector lately in an attempt to take advantage of some promising emerging share price uptrends. In other words, the charting, or technical outlook, is promising.

There is good value in this sector too. When the technical picture confirms the positive fundamentals, you know you’ve got a potentially successful investment on your hands. This is a key part of the SMSI investment philosophy…making sure the fundamental and technical stories are in agreement.

I’m not going to reveal this promising sector today. But it is the subject of a special report I’ve put together for you. Hopefully you should be able to access it by the end of the week.

Stay tuned…


Greg Canavan+,
Editor, Markets and Money


Join Markets and Money on Google+

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money