The price of iron ore has fallen hard.
Following a disastrous run throughout 2014, the latest price fall saw the steelmaking ingredient sell for just $US82.20 per tonne. This takes the percentage loss to nearly 40% since the beginning of the year.
The bad news for shareholders is, as I've previously mentioned in this article, many ASX-listed iron ore miners' profit margins will be stretched. Arrium Ltd (ASX: ARI), BC Iron Limited (ASX: BCI), Mount Gibson Iron Limited (ASX: MGX), Atlas Iron Limited (ASX: AGO), Grange Resources Limited (ASX: GRR) and Gindalbie Metals Ltd. (ASX: GBG) are in the firing line, make no mistake.
Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) have total costs less than $US50 per tonne and appear safe, for now. However, one look at the 20-year price chart below should remind us, the iron price spot price could fall significantly lower in the future, possibly as low as pre-2007.
20-year monthly average iron ore price. Source: Indexmundi.com
8 ways to profit from a volatile commodity price
Here at The Motley Fool Australia we champion long-term investing but, as savvy investors know, volatility brings opportunity for both traders and buy-to-hold investors.
Depending on your stance, bullish or bearish, here are eight ways you could benefit from the falling iron ore price (note the underline).
The Bears – i.e. you think iron ore will fall further
- Sell your ordinary shares in iron ore companies – Sometimes (if not always) saving money is just as important as making it!
- Write call options – You'll receive an upfront premium for giving another investor the right to buy a stock at a given price until expiration.
- Short the stock prices of iron ore miners. Personally, I believe this is a very high-risk strategy because your downside is unlimited.
- Buy put options. You pay the "writer" a fee for the "right" to sell a stock for a predefined price.
The Bulls – i.e. you think iron ore will rebound
- Buy ordinary shares in iron ore miners. Very simple and can be used for short or long-term benefit.
- Buy call options. You pay the "writer" an upfront fee for the "right" to buy a stock for a predefined price.
- Write put options. You receive an upfront premium for giving another investor the right to sell a stock at a given price, until expiration. This strategy can work well to provide an income stream. The Motley Fool General Manager, Bruce Jackson recently gave an excellent example of how it works, in this article.
- Buy ASX call warrants. These come in a variety of flavours and have similar characteristics to options but are usually longer-term contracts. However, these can sometimes be very illiquid.
Is this your best option?
Iron ore could rebound in the short-term but analysts at Goldman Sachs and CLSA are forecasting even lower prices in coming years. I'm steering clear of high-cost iron ore miners, including Fortescue Metals Group Limited (ASX: FMG) – which has an estimated all-in cost between $US70 and $US80 per tonne. I only have exposure to Rio Tinto, the lowest cost producer in the world.
The world of derivatives (options, warrants, shorting etc.) is, in my opinion, best done in moderation and even considering entering it without doing a large amount of research is a very risky proposition. It's also important to remember, we don't have to buy every stock on the market (we could avoid iron ore altogether!) and there are no penalties for exercising patience.
That's why I recommend long-term investors take option number nine: Avoid iron ore miners altogether!
