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Broker upgrade sends Fortescue shares hurtling higher

One of the best performers on the S&P/ASX 200 index on Wednesday was the Fortescue Metals Group Limited (ASX: FMG) share price.

The iron ore producer’s shares snapped their losing streak with a solid 4.5% gain to $7.56.

Why did the Fortescue share price charge higher?

Whilst improving investor sentiment due to easing trade war concerns gave its shares a boost along with BHP Group Ltd (ASX: BHP) and Rio Tinto Limited (ASX: RIO), I suspect a broker note did the majority of the heavy lifting.

According to a note out of Goldman Sachs, its analysts have upgraded Fortescue’s shares to a buy rating with a $9.80 price target. Even after today’s strong gain, this price target implies potential upside of almost 30% excluding dividends.

The broker made the move on the belief that iron ore prices will rebound due to a structural deficit.

Goldman explained: “In our view, the recent sharp price fall in iron ore was driven by looser market conditions in China – on the back of higher iron ore imports and slower steel production growth – and negative sentiment stemming from trade war escalations. Nonetheless, the iron ore market remains tight: 2019 is on track to post the seaborne market’s first deficit in seven years, and the widest since at least 2000. We see a deficit through 2020, with only a finely-balanced market emerging in 2021.”

It also believes that prices have to rebound in order to ration demand.

It suggested that “prices have to rise to either generate a sufficient supply response or, more likely, destroy enough demand to achieve a balance.”

The broker believes the latter is more likely because global iron ore supply growth is limited by regulatory and environmental issues in Brazil and production problems in Australia.

In light of this, Goldman Sachs has lifted its iron ore price forecasts for the near term.

“We raise our 3-, 6-, and 12-month price forecasts to US$115/US$100/US$85/t, respectively, from US$91/US$80/US$72/t prior. This implies annual averages of US$100/US$90/US$75/t for 2019/20/21. The key changes to our iron ore balances are higher-than-expected Chinese steel production and supply disruptions in Australia. Given the tight fundamentals, we expect the forward curve to remain steeply backwardated.”

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. 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 Scott Phillips.

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