Fortescue sold off on China concerns

Just a few weeks ago it seemed iron ore miners were finally ready to take the next leg higher with a turnaround in earnings backing them up.

Fortescue Metals (FMG) rallied heading into its first-half results which were released on February 19. The report showed strong iron ore sales and this, along with a rising iron ore price really helped the stock rally to its highest since March 2012. Being a pure play, FMG is heavily leveraged to iron ore price moves and as a result is quite sensitive to the price action in iron ore and consequently developments in China.

Since bottoming out in June last year (below $3), FMG put on a whopping 117% to its February high of $6.22. This high was printed shortly after the results were released. At that time iron ore was trading at around $124/t. In the past we’ve heard FMG say $120/t is the breakeven point for its operations, and as a result anything below this level is likely to see it redlining. The iron ore price has since dropped to $104.70/t and is down 15% from where it was trading when FMG hit $6.22.

Iron ore hurt by financing and growth concerns

It’s been an extremely tough week for iron ore, with sharp drops lodged yesterday after a very disappointing trade balance reading from the weekend. There are a few things causing the whippy price action in iron ore at the moment, with the key reasons all to do with China. Financing and macro demand worries were the two dominant themes that resulted in panic selling. Fears of a corporate bond collapse leading to a liquidity crunch along with destocking on forced bank selling saw the losses accelerate.

The switch from using copper to iron ore as collateral for shadow banking had seen iron ore inventories rise. A lot more iron ore is needed to hold an equal value of copper. As a result, falling iron ore prices simply amplified the destocking process. Analysts estimate a third of China’s port inventory is tied up in financing trades which is much bigger than the usual 10%. Trade balance numbers showed iron ore imports dropped to $7.91 billion (from $11.35 billion), but were still up 20% year-on-year. While iron ore concerns will remain in the near term, banks are more likely to hold on to stock until prices stabilise. This could be a saving grace for the bulk commodity in the near term.

Key levels to look out for

With this in mind, investors will be wondering when the best time to buy FMG is. The stock dropped to a low of $4.67 today and managed to find significant buying off those lows. The $5 level had been support for a while and the mere fact it closed below that level yesterday is concerning in the near term. Should the stock manage to close above $5, it might arrest the slide in the short term.

From a trading perspective, I would want to see the stock trade back above $5.20 which is where the gap created on Monday’s open starts. Such a move could then possibly see the gap filled and FMG trade back up to $5.50. From a bargain-hunting investor’s perspective, the 50% retracement of the move higher from below $3 to the high of $6.33 is at $4.55. This could be a good level for investors to accumulate in anticipation of a medium- to long-term recovery.

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