Fortescue shares go gangbusters as iron ore rockets

Credit: Chatham House

The share price of Fortescue Metals Group Limited (ASX: FMG) is up around 9 per cent today and 41 per cent over the last month as the price of iron ore unexpectedly zooms higher over the course of 2016.

Today’s price of US$48.52 a tonne is substantially above lows just above US$40 a tonne seen through much of January in a price rebound that has also helped support the share prices of the iron ore majors Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP). Their shares are 3.4 per cent and 3.6 per cent higher respectively today, as the iron ore price rise triggers a relief rally among beaten-down resources stocks.

Fortescue though is especially leveraged to the iron ore price swings due to its mountainous debt piles, which mean investors tend to rush for the exits once the iron ore price falls towards Fortescue’s break-even cost of production. This is because some believe if iron ore were to fall significantly further then Fortescue’s debt pile could sink it for good, or force a dilutive capital raising at a substantial discount to exchange traded prices.

Fortescue shares collapsed in tandem with the iron price from above $6 in 2014 to under $1.50 just last month and today shares sell for $2.17. Anyone tempted to punt on them rising again would need to expect sustained iron ore price rises on the back of falling global production and rising demand from China in particular.

The supply side is reported to have been affected by the catastrophic collapse of a tailings dam in Samarco Brazil at an iron ore mine jointly operated by BHP and Brazilian miner Vale. However, BHP, Rio Tinto, Fortescue and the privately-owned Hancock Prospecting continue to lift overall production in a fight for market share as China’s construction super-cycle eases off from once-in-a-generation levels unlikely to ever be repeated again.

The recent iron ore price rise is also due in part to US dollar weakness as iron ore is priced in US dollars and thus becomes more affordable to non-US dollar denominated buyers. However, the strength of the US economy relative to the rest of the world suggests the US dollar is likely to remain strong throughout the rest of the year and its recent weakness may reverse quickly to put more pressure on iron ore prices.

Investors then need to consider that China’s economy is transitioning and the iron ore market is likely to remain oversupplied for a long time yet. Overall, Fortescue shares don’t look a smart investment, especially versus other companies that have much more attractive economics and outlooks.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

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Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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