Are We Comfortable With Our Iron Ore Exposure?
Over the last-3 days, the ASX200 has regained some internal strength, actually managing a small rally in the face of some minor adversity e.g. US stocks drifting lower and iron ore testing 12-month lows. Technically we can now see the local market challenge the psychological 5800 area over the next few days, aided by last night’s solid rally by global indices before seasonal weakness is again likely to take hold.
The stand out sector over the last few months has been the local “yield play” stocks, primarily at the expense of banks and growth / expansionary stories. For example since February, we have seen Transurban (TCL) rally +22% and Sydney Airports (SYD) +30%. We called both of these stocks to bounce at the start of 2017, but certainly not to the degree they actually have. Conversely, over the same timeframe we have seen Commonwealth Bank (CBA) fall -3.3% and BHP Billiton (BHP) -12.8%.
ASX200 Daily Chart
US stocks again rallied strongly last night, with the broad based indices making fresh all-time highs. We still see a further 2% upside for the Dow, before some consolidation is due. This is yet another example of a market not falling when too many people are predicting it. We cannot help but wonder if Australian property prices will follow suit with so many “experts” forecasting their demise.
US Dow Jones Daily Chart
Investors have lost some confidence in a rapid global economic recovery as President Trump appears to be juggling a number of balls, as opposed to focusing specifically on the areas of growth. One of the best illustrations of the markets deteriorating optimism is the US 10-year bond yield, which has drifted back towards 2.2% after powering from 1.3% to over 2.6% in just a few months.
However at this point in time, we continue to believe the pullback in bond yields simply represents a mild correction after over doubling very quickly. If this view proves correct, the likelihood is we will see a reversal in performance from the “yield play” stocks to the banks and growth stocks.
US 10-year bond yields Weekly Chart
Today we are going to briefly look at 3 iron ore stocks, who sit in the cross hairs of a declining Iron Ore price. For these stocks to rally, it’s highly likely we need some renewed confidence in the global economy and of course, China. Iron ore futures have plummeted 40% in 2017 and for our current bullish stance to prove correct, we are likely to need a bounce from the current $US55/t area.
Iron Ore Monthly Chart
1 Fortescue Metals (FMG) $4.67 – not $3.67 as yesterday’s afternoon report suggested!
We have enjoyed a number of forays into FMG over the years with yesterday’s purchase around $4.66, arguably one of the most aggressive – we’ve almost caught the falling knife, which can be a dangerous game. However, we had planned this entry for over a week and we remain confident with our $5.50 target area - technically a close over $4.80 will give us a large degree of confidence.
We like the fact that FMG had already bounced 18% once (to $5.50) after its mid-May lows, implying to us perceived value in the stock by market players once iron ore finally stops falling, let alone a rally!
Fortescue Metals (FMG) Weekly Chart
2 RIO Tinto (RIO) $61.75.
No change we remain bullish RIO targeting over $70, we get a degree of comfort that RIO has rallied strongly from its early May lows. The stock is currently valued on an undemanding 9.8x 2017 earnings, while paying an est. 3.6% fully franked yield.
Similar to FMG, if / when iron ore stops falling, RIO looks poised to continue its recovery.
RIO Tinto (RIO) Weekly Chart
3 BHP Billiton (BHP) $23.73.
BHP has had the proverbial sink thrown at it over recent months, with both iron ore and crude oil prices falling substantially. However, we now believe the stock is being valued from a “glass half empty” perspective which by definition, creates a large degree of potential upside. The stock is currently valued on an undemanding 12.2x 2017 earnings while paying an est. 3% fully franked yield.
Similar to FMG and RIO, if / when iron ore stops falling, BHP looks poised to continue its recovery.
BHP Billiton (BHP) Weekly Chart
Conclusion (s)
We undoubtedly have our largest ever exposure to both resource stocks and iron ore, just when they are a touch on the nose i.e. BHP, FMG and RIO. We are currently comfortable with this exposure, happy to go against the crowd, but will remain prudent from a risk / reward perspective incase the iron ore weakness continues to unfold – FMG is likely to be the first stock we sell both on a rally, or a fall if we are wrong.
Overnight Market Matters Wrap
· The US equity markets rallied overnight, after positive economic data - Private payrolls increased by 253,000 jobs last month, ahead of expectations of 185,000.
· Risk was certainly back on, ignoring China’s weaker than expected manufacturing PMI data yesterday, with both the financials and major miners to outperform the broader market today – e.g. BHP in the US closed up and equivalent of 0.53% higher from Australia’s previous close.
· The June SPI Futures is indicating the ASX 200 to open 30 points higher, towards the 5,770 area this morning.
Disclosure
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