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The pebble drops


The pebble drops

There is an old chinese proverb that says “a pebble cast into a pond causes ripples that spread in all directions” – as Michael’s email over the weekend (below) displays,  there’s a shift going on which is rippling its way through the market.

            Date: 9 September 2012 9:47:05 AM AEST
            To: <roger@rogermontgomery.com>
            Subject: Re: Iron ore related video

Morning Roger,

Below is a link to an ABC Newsline video from a few days ago. You may have already seen it.


I thought this might be a good link to post on the blog, aimed at all the iron ore bulls in total denial…..

Let’s see what happens to pricing when some of the Chinese steel mills put their hands up and say “We don’t require anymore iron ore at the moment thank you”.

They have done this before many years ago and why can’t it happen again. Then let’s see how quick we end up sub $50 per tonne.

As you’ve being saying for months now Roger, how on earth can all this new supply coming on line find a home…. Oversupply, demand slowing. I certainly can’t see much chance of an up arrow in the iron ore price.

How good was Jim Chanos’s short call on FMG, well and truly in the money….

Kind Regards



Falling demand sees iron ore build up China ports: report

Published 8:09 AM, 6 Sep 2012

Iron ore has continued to build up at 25 major ports as Chinese steel makers posted widespread losses over the seven months to July, Xinhua News reports.

According to the news agency, iron ore inventories waiting at ports increased 1.86 million tonnes to 102.53 million tonnes last week.

Xinhua analysts have blamed the build up on weakening demand for the product.

“In the short-term, the iron ore market will continue to suffer from oversupplying and the downward trend seems irreversible,” Xinhua analysts said in the report.


Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.


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This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice 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 advice from a financial advisor if necessary.


  1. An iron ore price of $90 t is very high and an awesome price for the minners. If the aus $ was at 70c it would slip into “super profit” territory. When FMG, the “3rd force” in iron ore, secured the bulk of its debt ( 7 billion) in 2006, the price had just doubled to $33 per t. The banks were very happy to lend it on such an awesome price ( it had sat under $10 pt for ever) . In may of 2008, FMG loaded its first iron ore onto a ship, the price had doubled again to $60 pt. This price was thought to be just bonkers in the industry. I was working for Bhpb iron ore, and the word was to get as much on the ships in the next year as possible. And it did, they went from 95mt to 120mt that year. The push was so great that from July 2008 to march 2009 ( 8 month period) 5 workers died. It was gold fever on a massive scale. The widly held view was the huge $60 t price may last a year, 2 at tops. Bhp pushed its planned “rapid growth expansion ” plans with intensity. Their costs had blown out to $22 pt, but who cared, they were making a fortune. Then in 2009 China had a $ 1 trillion stimulus package. Boom, someone threw petrol on the fire. All the iron ore miners seem to have a ” build it at any cost”attitude. Contractors would double their prices and still win the job. In 6 years bhpb iron ore costs went from $22 to $44 per t. They Want to blame everything else except themselves. Their totally shocking management is what caused it. Once you let the geni out of the bottle, it’s hard to get her in again. You have a look at any buisenes, in any industry, and If their costs have doubled in 6 years, they are going to be in big trouble. The banks that lent FMG the latest debt for their 100mil/ t expansion deserve to loose their money, their calculator musn’t have been working that day. They just got caught in the gold fever. So yes, of cause the iron ore price will go down, and the miners will just have to operate leaner, it’s always been a skinny industry. When your a price taker, that’s just how it is . Thanks for reading
    Cheers Gary .

  2. FMG’s problem is the debt-fueled expansion. It shouldn’t have much debt at all. After reviewing the past few annual reports, I posted this back of the envelope calculation for FMG on 1 September:


    12 days have been a long time for FMG with debt covenant relief discussions between FMG and its banks announced today.

    Commodity prices will bounce around and iron ore is no different. However, I think a bigger issue is that iron ore is priced in USD and the USD should not be worth as much tomorrow as is today. So Jim Rogers is most likely right, the price of all commodities (being priced in USD) will rise in the long-run. What happens in the short-term, depends on short-term supply-demand dynamics and China must go through their leadership transition before any significant response to a significant short-term downturn can be made.

    I’ve downloaded the following data (2011 based) from the IMF database.

    For China:
    Gross domestic product, current prices in Yuan: 34,979
    Gross domestic product per capita, current prices in USD: 5,414

    For USA:
    Gross domestic product per capita, current prices in USD: 48,387

    This suggests that China still has a labour wage rate advantage over the US. However, this does not take into account that the US would generally use capital more productively.

    For China:
    Total investment (per cent of GDP): 48.3
    Gross national savings (per cent of GDP): 51.0

    For USA:
    Total investment (per cent of GDP): 15.9
    Gross national savings (per cent of GDP): 12.9

    So although China’s investment appears to be high at first glance, their gross national savings exceed investment as a percentage of GDP and should be less of a concern compared to the US which has a lower savings rate relative to investment.

    2011 China unemployment rate: 4%
    2011 US unemployment rate: 8.95%

    China General government borrowing (per cent of GDP): 1.2
    USA General government borrowing (per cent of GDP): 9.6

    The US fiscal cliff is looming. How will this play out in the US economy if the US budget deficit drops to 2%? Another recession is likely if it happens.

    For China in 2011:
    General government net debt: 0
    General government gross debt in USD billions: 1886
    General government gross debt (in per cent): 25.8 and forecast to decrease.

    For USA in 2011:
    General government net debt (USD billions): 12,117
    General government net debt (per cent of GDP): 80.3
    General government gross debt (USD billions): 15,537
    General government gross debt (per cent of GDP): 102.9 and forecast to increase.

    So China has no net debt and the US has significant net debt.

    With a reported 2 trillion in USD foreign assets and 1 trillion in non-USD foreign assets (from memory from newspaper article), China has some firepower to respond domestically to any decline in net exports. This would involve selling USD assets and buying yuan, hence depreciating the USD dollar. So long-term, I think commodity prices (across the board) should increase in USD terms.

    The other major problem is QE. Why hasn’t this caused inflation already? Very intriguing. When the Federal Reserve buys treasury securities from banks, they have cash to lend but have been hoarding cash by depositing the cash with Federal Reserve banks. See:


    Examine “selected liabilities from the Federal Reserve” from 2007.

    Taking two dates, US deposit taking institutions had on deposit with the Fed banks:
    $20 bn on 17 Aug 2005 (from statement data).
    $1528 bn on 5 Sep 2012.

    So why hasn’t this money been lent out to stimulate the economy? Probably because banks have to deleverage to improve Tier 1 capital for new Basel III regulations. I’d like to know how their capital ratios are stacking up now.

    But when they do start to lend again, which could still be years down the track if deleveraging takes a long time, that $1.5 trillion in deposits would have a multiplier affect throughout the economy that should lead to high inflation and high interest rates. The Federal Reserve will attempt to sell treasury security assets to take money out of the system, but higher interest rates should result. It’s a messy game.

    US government gross debt is now at 16 trillion but the bigger issue is the present value of unfunded future medicare liabilities, pension cost, medicaid etc. which according to Bloomberg TV this week is 65 trillion USD.

    In a nutshell, this looks extremely bad for the USD. Commodity price volatility will probably increase going forward, with commodity prices overshooting and undershooting equilibrium prices based on supply-demand fundamentals alone.

    The RBA put out a “Chinese Urban Residential Construction” report today. See:


  3. Michael,

    Spot on with Chanos.

    FMG you know your in trouble when…….

    FMG – Dear Bank of America Merrill Lynch thank you for approving our $1.5b in term loans last month (Aug 2012)

    Bank of America Merrill Lynch – not a problem FMG, we are happy to provide you with the funding considering you agreed with all our strict covenants.

    1 month later

    FGM – hey BOA et al, could we have reprieve on our loan covenant…. Please

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