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FMG $4.19

Is the rally over?

  1. mrhammond

    159 Posts.

    Has the rally ended? I certainly call an end to the rally. I've sold. Like many others, I bought heavily around the psychological $2 mark, just before the quarterly production update. What luck! But I don't think the announcement was the only reason for this rally. Essentially, the $2 threshold represents, more or less, the low point that FMG reached during the GFC. And we all know what happened then-- it was a fantastic buying opportunity!!! (Which I largely missed, because at the time I didn't have the ability to self manage my super). But who cares about me, the fact is I saw a repeat of the post-GFC opportunity, and so I took a punt, put in all the money I possibly could, and I was rewarded, and saw my investment shoot up from $2 to $2.50 -- 25%! And I wasn't alone. Now the question is, will the price keep going up? If the price goes from $2 to $2.50 in such a short time, is $3 just around the corner? Unlikely. Looking at the trend for the past year, you see swings like this all the time, except they become more noticeable the lower the price gets. A swing of 50 cents at the $5 mark is only 10% (such as back in March/April 2014). Now a 50 cent swing is 25%! FMG is becoming a traders delight. But its also becoming increasingly attractive to investors who have never held FMG before, such as overseas investors, or others who predicted the commodity bubble would burst. So where is the FMG price heading now? I see that the traders will create some volatility, but in the short term I see that FMG will hover around present levels. The rally might continue a little longer, especially if the Aussie dollar keeps falling, but these are short term comforts in an oversupplied market, with Rinehart's Roy Hill poised to swamp the market with even more supply over the next few years. Also, I think its fiction to believe that all loss making mines will shut down overnight. There is a spectrum of profitability, and obviously those at the far end of the spectrum (in terms of loss making) will shut down first. Those at the other end (the low cost producers) will keep flooding the market, because as long as they make a profit, why wouldn't they? Then there is the mid-field, those that are simply treading water or are running at a loss. These won't shut down immediately. There will be capital raisings. They will fight for survival. So what I see a process that will take some years to fully play out, in which time the supply of iron ore will continue to exceed demand, and so its too early to really value any of these mid-field mining stocks. And Fortescue is arguably in that mid-field. It may still be making a profit at the moment, but that in itself doesn't make it a low-cost producer. The term "low cost producer" is somewhat subjective. Your cost may be relatively low to other producers, but that doesn't necessarily mean you are profitable, or will remain profitable. And with billions of debt, I believe that Fortescue is still overvalued. Whilst the recent rally may be the result of the recent quarterly production update, I believe that this sits on the back of a psychological support barrier at $2, which is also somewhat subjective. Essentially FMG has reached its post GFC lows, and that created a level of support. On top of that, we seen a rally on the back of the cost reductions announcement in the quarterly production update. But over time, we will see that these two factors diminish in strength. Over time, we will see an ongoing environment of low and volatile iron ore prices. We will see volatility in the FMG share price. We will see the $2 psychological barrier challenged again, and again, and again, until finally the mentality of "FMG can't go below its post-GFC lows" is exposed as nothing but fiction, and that the "bottom" of the FMG share price in the current trading environment will be completely independent to the bottom it reached after the GFC. There is no relationship between the two!! We see a continued slow down in China, we see sluggish global growth, and we see a near psychotic increase in iron ore supply from Australia. Even if the iron ore price somehow maintains current levels, or doesn't fall much further, then we still are likely to see a prolonged period before demand rises sufficiently. And depending on how long that process takes, it may create problems for Fortescue. There are capital expenditures that can only be deferred for so long. Infrastructure needs to be maintained, otherwise there is a risk of incidents that cause a material risk to production capacity. Oil prices may recover, leading to an increase in costs, offsetting any benefits from what will likely be further falls in the Australian dollar. Its a complex landscape, and sometimes its impossible to see through it all with lucidity. But in a few years time when we look back, we may find, with the benefit of hindsight, that there were some very simply red flags that we chose to ignore. And we are already beginning to wake up. The term "too big to fail" is already a mainstream term. But have we applied it to Fortescue? Do investors genuinely believe, perhaps subconsciously, that Fortescue is "too big to fail"? Is there a tendency to look at the historical charts (which suggests that FMG has support around $2)? I think we need to question Fortescue's value, and only time will tell what its actually worth. Are they going to pay a dividend this year? How much? What happens when Fortescue makes announcements about that? Yup, there will be a reaction. So expect volatility. Traders are selling out, sensing the end of this rally. And others would be wise to either follow suit, or not get caught in a short lived bull run that will burst in the short term once the dividend announcement is made. And in the medium term, we are not going to see a sustained recover in the iron ore price that justifies the current market valuation of Fortescue. $2, for me, remains the most I'm willing to pay. Because quite frankly, even that is probably too high.

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