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Iron ore plays and market perversity

2 Sep 2021 8 month(s) ago

Some investment assessments of iron ore companies and how global markets have had the usual surprises this year.

Australia’s economy very much rides on the back of iron ore and coal, both of which have been doing well. One of the difficulties for investors in companies that benefit from a high iron ore price is how to assess the importance of dividends.

Morgans has looked at that dynamic and is maintaining a Hold rating on BHP and Rio, and a Reduce rating on Fortescue Metals (FMG). On a total return basis (capital gains plus dividends) Morgans thinks there is more risk in the future of weakness than strength.

“In the two most recent dividend periods, BHP/RIO/FMG have not been able to carry their dividends once going ex, and we expect that to occur again this half. Having already outperformed, we still see BHP as the best placed of the big miners given its diversification and lack of operational/strategy issues (vs RIO/FMG).

“In particular RIO and BHP have both outperformed iron ore prices over the last month, while FMG’s share price has trailed its bigger peers.  While we expect the big miners to come under selling pressure once they go ex- dividend, we do expect strong equity market support around their dividend announcements.”

Such dynamics do not matter greatly to long term investors, though. “This is a tactical call not relevant for all long-term investors," notes Morgan. "The market knows strong results are coming.

"BHP remains our top preference of the three big miners, despite having already materially outperformed so far in 2021. We view the big miner as a core holding for most clients and benefiting from its better diversified business.”

Citi has noted that the party may be over for the iron ore price, something that investors will price in. "Iron ore prices have fallen 37% over  four weeks to $140/t with Chinese steel demand weakening. We expect iron ore to move into surplus in the second half as demand slows, supply recovers  and steel scrap lifts; we expect this to result in iron ore prices trending back to the cost curve, reaching $100/t by mid-22 & $75/t in 2024."

That may over time put some of those dividends from the iron ore players under pressure.

Meanwhile, Deutsche Bank has released data on which asset classes have done best in the year to date. Of course, assets that have gone up most in recent history are often the ones that are weakest in the near future. Super fund ads persistently acknowledge in their ads that past performance is not a guide to future performance. That is not only true, past performance is often directly contrary to future performance.

However, it is worth seeing which assets have done well this year. Top performer is oil (West Texas Intermediate and Brent crude) and copper, indicating that commodities are far from dead, despite the global crisis. Precious metals have been hammered. Silver is the bottom performer and gold is near the bottom. American shares: the Dow Jones, S&P 500 and NASDAQ, have done extremely well.

So many consensus expectations proved wrong, as ever. The US share markets continued to rise, risk aversion plays based on buying gold and silver did not pay off, and commodities are looking pretty strong (including the much maligned coal). Go figure.



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