Atlas, BC Iron in freefall as investors head for exit

THE sell-off in iron ore equities has continued, putting the Australian sharemarket back into a short-term downtrend.

THE sell-off in iron ore equities has continued, putting the Australian sharemarket back into a short-term downtrend for the first time in four weeks, even as offshore markets rose slightly.

It was the second-tier iron ore producers where most of the damage was done. BC Iron lost 10 per cent and Atlas Iron plunged 14 per cent, hitting a record low of 21 cents.

Losses in the bigger players — BHP Billiton, Rio Tinto and Fortescue Metals — were a little more subdued, falling between 1.8 and 2.8 per cent.

The falls came about despite a three-day lull in price falls of the physical iron ore. Even so, the spot price hit a five-year low of $US75.38 per tonne last week, more than 60 per cent below its 2011 peak of $US191.70.

Despite an already high degree of short positioning in the pure plays — Fortescue and Atlas are among the top 12 shorted stocks in the S&P/ASX 200 — sharply lower iron ore price forecasts from the likes of ANZ and Citi this week have had a significant negative impact on market sentiment.

Investors are increasingly concerned that with BHP and Rio responding to price declines by pumping out even more iron ore, prices won’t rebound quickly and indeed could fall further.

Combined with widening discounts for lesser-quality ore, forced production cutbacks and tighter credit conditions for some Chinese mills, and “sticky” Chinese iron ore production, increasing supply from the major low-cost producers has created a perfect storm for the higher-cost pure plays.

Fortescue chairman Andrew “Twiggy” Forrest warned yesterday that BHP and Rio were threatening Australia’s relationship with China by flooding the market with iron ore in a bid to kill off their rivals, including Chinese producers of the commodity.

But the trouble for the higher-cost domestic producers, like Fortescue, is that China’s high-cost iron ore production may remain sticky because of vertical integration and government policy in China.

“People may be looking for supply cuts in the wrong place,” says Pengana Capital portfolio manager Tim Schroeders. “Social imperatives more so than the cost curves will dictate supply cuts. It’s not all about cost of production in China. It’s also about social harmony and keeping people employed.”

Bearing in mind that the solid funding position of the major producers means there’s little doubt about their expansion plans, the question is how long can some of the marginal local producers survive with iron ore prices below $US80 a tonne.

Takeovers are increasingly likely, but there has been little chatter on that front.

At the same time, while investors have been switching from the pure plays to the major diversified miners, BHP and Rio’s share prices may have been a little too resilient this year, according to Mr Schroeders.

“It could be argued that the smaller iron ore miners have fallen too far versus BHP and Rio Tinto,” he says.

“It’s incongruous to think that those stocks are down only about 13 per cent since the start of the year when you consider how much of their earnings are derived from iron ore, which is down 44 per cent. They will need a lot of cost offsets and value increases to offset the price declines.

“The carrots that are being dangled in front of investors in terms of potential capital returns and spin-offs can only keep the faith for so long, I suspect.”

Goldman Sachs actually upgraded Fortescue to a “neutral” from a “sell” arguing the 48 per cent fall in the share price over the past 12 months was starting to draw out some value.

The investment bank said that despite the drop in Fortescue’s cashflow, the miner will be able to extend its debt maturity profile without triggering a capital event.

Based on Fortescue’s share price weakness and its $US75 long-term forecast for iron ore, Goldman Sachs said the key planks of its previous negative view on Fortescue were now largely priced in. That didn’t stop the share price falling.