{"id":32091,"date":"2012-09-05T00:20:11","date_gmt":"2012-09-05T04:20:11","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/2012\/09\/with-iron-ore-prices-falling-will-fortescue-break-the-buck\/"},"modified":"2012-09-05T00:20:11","modified_gmt":"2012-09-05T04:20:11","slug":"with-iron-ore-prices-falling-will-fortescue-break-the-buck","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2012\/09\/05\/with-iron-ore-prices-falling-will-fortescue-break-the-buck\/","title":{"rendered":"With Iron Ore Prices Falling Will Fortescue \u2018Break the Buck\u2019?"},"content":{"rendered":"

By MoneyMorning.com.au<\/a><\/strong><\/p>\n

Breaking the buck is a term used to describe when a money market fund (basically a fund that holds cash) falls below a net asset value (NAV) of $1.<\/p>\n

It’s something that shouldn’t happen because the fund fully invests in cash; $1 should be worth $1. But breaking the buck can happen. The last time it happened was in 2008. That’s when it turned out that many money market funds didn’t just invest in cash, they invested in derivatives<\/a> that mirrored a cash asset.<\/p>\n

So when markets froze in 2008, the funds couldn’t value the derivatives and therefore had to mark them down. This caused the NAV to fall below $1, and created a run on these funds as investors scrambled for the exit.<\/p>\n

This had a domino effect because it caused the NAV to fall further as the funds had to liquidate assets quickly in order to meet redemption requests.<\/p>\n

What does this have to do with Fortescue<\/strong>?<\/p>\n

<\/span><\/p>\n

Well, the question for Fortescue Metals [ASX: FMG]<\/strong> investors is whether that company will ‘break the buck’. We mean that both in terms of the share price falling below $1, and the company turning a loss as its costs exceed expenses.<\/p>\n

Because as the Australian<\/em> reported yesterday:<\/p>\n

‘Fortescue admitted that it was not profitable at current iron ore price levels but said that the measures would bring the company back to profitability, even if prices stayed low.’ <\/em><\/p>\n<\/blockquote>\n

Is this the finally the end of Fortescue’s dream run? And what should you do as an investor? We’ll give you our take on it below…<\/p>\n

As recently as 8 June we wrote<\/a>:<\/p>\n

‘The big Aussie miners have already taken a tumble this year. BHP is down 26%, Rio is down 30%, and Fortescue is down 27%.<\/p>\n

‘Our bet is all three have much further to fall.<\/p>\n

‘And quite frankly, we doubt if there’s a better trade in the world to sell China’s economy than the opportunity Aussie investors have to short sell these three stocks.’ <\/em><\/p>\n<\/blockquote>\n

Of course, that wasn’t the first time we had warned you about the Aussie bubble economy, or considered the best way to profit as it bursts.<\/p>\n

On 8 May, Shae Smith warned about the dangers of the iron ore bubble. In an article titled, ‘Fortescue Metals: Why This Stock Will Slump When Iron Ore Prices Fall<\/a>‘, she explained why famous hedge fund investor, Jim Chanos<\/a> was short-selling Fortescue Metals.<\/p>\n

In short, Chanos believed Fortescue could struggle to repay its debt if iron ore prices fell below USD$100.<\/p>\n

Today, the iron ore price<\/a> is USD$89 per tonne, and the Fortescue share price has dropped another 27% since our June article (it’s down 37% since Shae’s May article, and down 46% since the peak in March).<\/p>\n

But all that’s history. What about now…<\/p>\n

Iron Ore to Bounce…or Not<\/h3>\n

<\/center><\/p>\n

Only last week, Fortescue Metals CEO, Nev Power told attendees at Sydney lunch that they shouldn’t worry. That the iron ore price would bounce. Here’s how the Age<\/em> reported Mr Power’s comments:<\/p>\n

‘The Fortescue chief executive said he expected the sharp decline in iron ore prices to be followed by a swift rebound, within a couple of months, to $US120 a tonne.’ <\/em><\/p>\n<\/blockquote>\n

If that were true, we’d say the company shouldn’t panic. Just hold in there. At worst, put production on care and maintenance for a couple of months, or even keep producing and take the loss on the chin.<\/p>\n

After all, if the price bounces, Fortescue should claw back the losses pretty quick.<\/p>\n

Oh, how things have changed…in just a few days.<\/p>\n

As we mentioned above, yesterday the Australian<\/em> reported:<\/p>\n

‘Fortescue admitted that it was not profitable at current iron ore price levels but said that the measures would bring the company back to profitability, even if prices stayed low.’ <\/em><\/p>\n<\/blockquote>\n

So, what are those ‘measures’?<\/p>\n

In short, Fortescue will complete development at one of its lower cost mines, while halting development at a higher cost mine ‘until iron ore prices return to more sustainable levels.’<\/em><\/p>\n

In other words until the iron ore price goes back to USD$120 a tonne.<\/p>\n

Hmm. It’s an interesting turn of phrase, ‘until iron ore prices return to more sustainable levels.’<\/em> Sustainable for whom?<\/p>\n

Sustainable for the iron ore producer<\/a>, or sustainable for the iron ore consumer?<\/p>\n

The Growth is Over<\/h3>\n

<\/center><\/p>\n

We’d argue that from a consumer viewpoint a lower price is always more sustainable than a higher price. And with the Chinese economy collapsing<\/a>, there’s absolutely no guarantee the iron ore price will ever return to USD$120.<\/p>\n

In fact, we’d argue there’s more chance that it will go lower.<\/p>\n

As the Financial Times<\/em> notes, ‘pretty much all of the projected increase in iron ore demand is expected to come from China’<\/em>:<\/p>\n

<\/div>\n
Source: Financial Times<\/strong><\/div>\n<\/p>\n

But if China’s economy stops growing<\/a>, or doesn’t grow as fast, it means trouble for iron ore. And if China was the cause of the iron ore boom, doesn’t it make sense that it’s the cause of the iron ore crash?<\/p>\n

Make no mistake, the slowing Chinese economy is bad news for Australia and Australian mining stocks<\/a>. And as we see it, it’s only set to get worse.<\/p>\n

And we’d say it’s even worse than Fortescue Metals is letting on. This morning the company announced:<\/p>\n

‘Fortescue Metals Group Ltd (ASX: FMG, Fortescue) is pleased to announce the sale of the power station at its Solomon iron ore mine in the Pilbara region of Western Australia to a wholly-owned subsidiary of TransAlta Corporation (TSX: TA, NYSE: TAC, TransAlta) for net proceeds of US$300 million.’ <\/em><\/p>\n<\/blockquote>\n

The words ‘fire’ and ‘sale’ spring to mind. Other words that spring to mind are ‘desperation’ and ‘going bust’.<\/p>\n

Last week Fortescue said everything was fine. And yet this week the company is laying off jobs, shutting down one expansion and selling off a key power plant. It just doesn’t add up.<\/p>\n

So Fortescue’s claim that this sale is all part of the company’s big plan is just hogwash. It’s a clear sign that Fortescue is in big trouble…confirming what we already knew and warned you about months ago…<\/p>\n

That is, Fortescue Metals isn’t a viable business at the current iron ore price.<\/p>\n

Is This the End for Fortescue?<\/h3>\n

<\/center><\/p>\n

Fortescue hasn’t sold the power plant to help it finance expansion plans, it has sold the power plant to generate cash flow.<\/p>\n

As the Australian<\/em> reported this week, Fortescue ‘was not profitable at current iron ore price levels’.<\/em><\/p>\n

You only have to look at the company’s latest financial report to see the problem:<\/p>\n

<\/div>\n
Source: Fortescue Metals<\/strong><\/div>\n<\/p>\n

Fortescue’s sales revenue was $6.681 billion. Its cost of sales was $4.015 billion.<\/p>\n

But here’s the important part. Fortescue’s cost per tonne shipped is USD$69.03 (actually USD$71.95 per tonne when you divide the cost of sales by the volume shipped).<\/p>\n

The average sale price achieved last year was USD$120. As we’ve mentioned, today the iron ore price is USD$89 per tonne.<\/p>\n

Deduct tax, financing costs, and expansion costs and Fortescue is in the red.<\/p>\n

There’s no doubt the iron ore price drop<\/a> has put Fortescue in a bind. It’s unprofitable at current prices, which will have a negative impact on its cash flow.<\/p>\n

But at the same time, if it has any chance of getting back to profitability it will need to spend more to expand production at its lower cost mines…which will also impact cash flow.<\/p>\n

Fortescue’s only hope is that Nev Power is right, that the iron ore price will bounce to USD$120 per tonne. But if he’s wrong and the iron ore price stays where it is, or falls further, there’s a real chance it could be curtains for the company and a financial wipe-out for those who own the stock.<\/p>\n

If you own the stock, or you’re thinking about buying or trading it, we suggest you read Slipstream Trader<\/em>, Murray Dawes’ comments below, first…<\/p>\n

Cheers,
\nKris<\/strong><\/p>\n

Related Articles<\/strong><\/em><\/p>\n

What You Must Do to Survive the Coming China Crash<\/a><\/p>\n

Take Advantage of the High Australian Dollar While You Can<\/a><\/p>\n

Why the Australian Economy’s Bet on China Will Fail<\/a><\/p>\n

\n<\/img><\/a> <\/img><\/a> <\/img><\/a>\n<\/div>\n


\nWith Iron Ore Prices Falling Will Fortescue \u2018Break the Buck\u2019? <\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

By MoneyMorning.com.au Breaking the buck is a term used to describe when a money market fund (basically a fund that holds cash) falls below a net asset value (NAV) of $1. It’s something that shouldn’t happen because the fund fully invests in cash; $1 should be worth $1. But breaking the buck can happen. The … <\/p>\n

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