The Fortescue Metals Group Limited (ASX: FMG) share price has outperformed the S&P/ASX 200 Index (ASX: XJO) since the end of October 2022.
Fortescue shares have gone up by 37% while the ASX 200 has only risen by 4.2%.
I don't think that Fortescue is going to rise by another 30%, but it's possible that Fortescue shares could deliver outperformance in the coming months.
Certainly, no one knows what's going to happen next. But, I believe there are compelling reasons why Fortescue shares can generate stronger returns than the market, yet it's just as possible that the company could see problems. I'll outline my thoughts on both sides.
Case for outperformance
The Fortescue share price has done well on the projection that the Chinese economy could open and rebound. If and when China's COVID settings are 'open', then the nation could see a strong economic rebound like many other countries did after the Omicron wave a year ago.
Confirmation of China's return to full economic activity could be another boost for the iron ore price. It would be wildly optimistic to think the iron ore price could get back to US$200 per tonne. But, it's possible that it could rise another US$10 or US$20 per tonne within the next six months if China reopens in March.
The Australian Financial Review reported an analyst at Commonwealth Bank of Australia (ASX: CBA) Vivek Dhar thinks the outlook for steel is good. CBA is forecasting that Chinese policymakers will change to 'living with COVID' at China's upcoming 'Two Sessions' policy meeting in March 2023.
I also believe the dividend can help Fortescue shares can deliver strong returns.
According to Commsec, Fortescue could pay an annual dividend per share of $1.43 in 2023. That would translate into a grossed-up dividend yield of 10%. The dividend alone could help deliver outperformance.
Case for underperformance
This may be about as far as the iron ore price is going to go if the bounce-back isn't as strong as the optimists are thinking.
The Chinese people may well want to avoid busy places as the population has largely sought to avoid the virus over the past three years. A reopening in China may be quite different compared to the experience in Australia and the US.
Plus, it was reported that China's central resources buyer, the China Mineral Resources Group, could start its operations next year. The new entity will reportedly make purchases on behalf of around 20 of the largest Chinese steelmakers. This could give the business "unprecedented negotiating power". According to reports:
There was no fanfare when CMRG was established in July, but people familiar with the matter told Bloomberg at the time that its creation was encouraged and closely monitored by top leaders in Beijing. They see a consolidated platform for buying resources as a way to strengthen the country's negotiating position in an unfriendly international environment.
We'll have to see how this plays out. I wouldn't want to buy more shares at the current Fortescue share price. I'd rather wait until investors are pessimistic about the iron ore price again.
