If it wasn't already apparent, the share prices of commodity companies are almost 100% dependent on the value of their primary commodity.
In a challenging market, that sensitivity increases even further and additionally becomes fuelled by speculation to drive some pretty wild bounces in share prices – as shareholders in Fortescue Metals Group Limited (ASX: FMG) and other miners can attest.
Fortescue shares have dropped 4.7% so far in trade today, on the back of a 0.41% decline in the value of iron ore yesterday.
Naturally the closer the sales value a miner's product gets to its break-even point, the greater the number of investors that get spooked and bail out, which causes a disproportionately bigger drop in share prices.
But today's fall appears to be due to more factors than that, especially considering the dollar's recent decline to under US$0.80 (which actually improves Fortescue's bottom line).
Investors appear to be particularly concerned with BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited's (ASX: RIO) apparent pursuit of a 'goldilocks' iron ore price, where there is just enough production to maintain healthy margins for their companies, but not a large enough margin to entice new competition to the arena.
Part of this strategy appears to involve putting competitors out of business by rapidly increasing production and keeping ore prices low.
Fortescue's chairman has launched a number of scathing tirades against the major miners, who appear to be turning a deaf ear and continuing with their anti-competitive practices.
It's not just Fortescue hurting either, with junior iron miners operating on a razor's edge of profits, and international miners gradually being forced out of iron ore markets. Coverage in Fairfax media today revealed that Australia's share of China's iron ore imports is up from 51% to 59% of total imports.
With such obvious market pressure from major players – not to mention other factors like a slow-down in Chinese demand – don't risk your money investing in anything less than the best players in the sector, Rio and BHP.
Smart investors are avoiding iron ore altogether for now (my shareholding in Rio dates from 2010) in order to better focus on companies with durable competitive advantages and resilient cash flows – not to mention dividends.
With the next interest rate move tipped to be down, not up, the stage could be set for another big influx into dividend-paying stocks.
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