It’s a Bear Trap! Be fearful when others are greedy
Its no news we have been warning investors about the risk of declining iron ore prices since late calendar 2011. Most recently we have been warning of a bear trap – the risk associated with buying stocks when they appear to be ‘cheap’ because they have fallen a long way but poor fundamentals are likely to see prices even lower.
Figure 1 outlines how The Montgomery Funds have been thinking about China, Iron Ore and our big miners.
Fig 1.
Our argument has been to ignore the macro-economic forecasting for China that grabs all the headlines and instead quietly examine the balance sheets of listed Chinese companies. Our work on steel makers, manufacturers of cranes, ships and road making equipment revealed since July that receivables were blowing out as was the days receivables calculation. We reported that days receivables had blown out for some companies from 10 days to 125 days(!) and we’d seen a tripling of debtor balances on balance sheets. Not good and you might like to seriously consider the expectations of mining execs that iron ore prices will bounce back up to a permanent US$120/t.
The sell-side analysts are catching up: Macquarie just wrote:
“Based on quarterly reported accounts from more than 2500 domestically-listed Chinese companies, we find an alarming increase in the aggregate working capital position and cash conversion cycle. The Materials and Capital Goods sectors appear most exposed to this trend, but an alarming deterioration is also seen in the General Retailing, Healthcare and Consumer Goods sectors.”
What does it mean for you and me? It means that companies that make stuff from steel are not seeing healthy repeat customers because their customers are going broke. So the companies that make stuff out of steel will not need more steel in the next three months and therefore calls for a jump in the iron ore price, we expect to be optimistic.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Fer
:
I agree. Our currency is still strong though, so I would suggest to everyone not to think twice and move a piece of your pie away from China and buy other type of international assets with good fundamentals, perhaps in South Corea or South America and hold them; it seems that for sure our AUD will go down to probably 80 cents in the next 6 months (hope not).
Roger, Is it just Iron Ore? what about Coal, Aluminium, Gas, Gold and other elements? regards, Fer
E Chong
:
Excellent analysis Roger with your remarkable predictions aligned with the fundamentals. The commodity used to be the most promising but has now turned into the most deceiving trap due to major fundamental shift. While many will still cling to their belief that could be a bounce due to China stimulus, I remain extremely cautious and skeptical if this would have any substantial long-term impact on this commodity price.
Ernest