Correcting the curve
Comment of the Day

October 29 2013

Commentary by Eoin Treacy

Correcting the curve

Thanks to a subscriber for this educative report from Deutsche Bank focusing on iron-ore. The full report is posted in the Subscriber's Area but here is a section
The chart below shows the performance of the Australian dollar to US dollar exchange rate and the spot iron ore price. While the general performance of the two track closely, there are periods of time where the performance is disconnected. From 2011 we saw iron ore prices weakening, but the Australian dollar remains strong, which made for tough operating conditions for the mining companies in Australia. These tougher conditions have prevailed in market sentiment over the last 6 months and haven't adjusted in our view for the closing of the pain gap, as the Australian dollar has finally weakened. In our view, we believe that the market has been comfortable pricing in a drop in the iron ore price, but not willing yet to price in the inevitable weakening of the operating currencies.

As an addendum to the A$ discussion, the other gap shown in the chart above occurred from the third quarter of 2007 when the spot iron ore price far exceeded the strength in the Australian dollar – This did not result in as large a boom as expected as the majority of iron ore exported at the time was sold on contract and not spot basis and the contract price was significantly lower than the spot prices achieved at the time.

The chart below shows the performance of the spot iron ore price in a number of operating currencies over the last ten years. The spot price is four and a half times higher than it was in 2003, but is three times larger in Australian dollar and Brazilian real terms (still a hefty increase, but not as large as the spot price suggests). The performance of the iron ore price in South African Rand has been significantly better with the received price in Rand terms now five and a half times more than it was in 2003.

Eoin Treacy's view The consumer, healthcare and technology sectors continue to lead and have been joined over the last year by the industrial sector. Resources shares on the other hand have been notable laggards. Oversupply of steel, new capacity coming on line and a generally weak global economy have all contributed to this condition. However, as the US recovers, Europe emerges from recession and Chinese growth rates improve, it may be time to re-evaluate the outlook for miners, not least because they are cheap relative to the wider market.

Rio Tinto and BHP Billiton have been largely rangebound since late 2011. They both found support near their lower boundaries in June and are currently mid-range. VALE's US listed ADR has held a progression of higher reaction lows since June and has completely unwound its oversold condition relative to the 200-day MA. It needs to hold above $15 if potential for additional higher to lateral ranging is to be given the benefit of the doubt. Cliffs Natural Resources, Ferrexpo and Atlas Iron are all also trading in the region of their respective 200-day MAs. Breakouts from these short-term ranges would help bolster the argument that demand is returning to dominance beyond the short term.

Australia's Fortescue Metals continues to pause in the region of its February peak. A break in the four-month progression of higher reaction lows would be required to suggest more than temporary supply dominance in this area. (Also see Comment of the Day on October 17th).

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