Sell side upgrades iron ore into perfect storm

Advertisement
images

What can I say. I fought the wave of miner upgrades last year on iron ore market dynamics and was proven right, but you can’t keep a good dill down. From the FT:

Miners took the London market higher after JPMorgan Cazenove strategists turned positive on the sector for the first time in two years. Their optimism was pinned on data showing an upturn in Chinese steel demand and commodity imports, as well as self-help support from falling costs. The second half of 2014 “will see the sector’s free cash flow improvement, capital returns potential and attractive relative valuation begin to be appreciated more fully”, said JPMorgan. “While the remainder of the second quarter could lack momentum, we believe this is an opportune time to build exposure ahead of expected second-half outperformance.” Rio, up 4.8 per cent to £33.40, was JPMorgan’s only “overweight” recommendation among the diversified miners. A free cashflow yield of 9 per cent in 2015 put Rio in a position to top up its dividend after hitting internal debt targets this year, the broker said.

BHP Billiton, up 2.7 per cent to £19.48, would be first to return cash with a payback of at least $3bn in July, said JPMorgan. But Rio could top that with a $4.75bn return to accompany its full-year results next February, equivalent to 4.6 per cent of its market value, it said.

Light volume in the wider market left the FTSE 100 higher by 0.6 per cent or 37.18 points to 6,851.75.

I asked yesterday what was holding up iron ore equities and here’s your answer. I can only repeat, in structural terms, iron ore is in surplus and it’s going to get much worse this year and next.

Advertisement

On the demand side, Chinese property, which accounts for 50% of steel demand, is entering a shakeout. Authorities have repeatedly declared there will be no rescue (although it will almost certainly come eventually).

In cyclical terms, China remains well stocked with iron ore and steel inventories and is going to destock those either this quarter or next.

Upgrading iron ore equities into the face of these mounting gales is mindbogglingly reckless.

Advertisement
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.