Fortescue Metals Group Ltd (ASX: FMG) has seen its share price storm higher in 2019 on the back of a rising iron ore price which has surged beyond $US100 per tonne for the first time in 5 years. Is the trend going to continue?
About Fortescue
Fortescue is an Australian iron ore company that was founded in 2003 by business tycoon Andrew ‘Twiggy’ Forrest. It is today one of the largest producers of iron ore in the world behind Australian mining giants BHP Group Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO).
Iron Ore Price On A Tear
All three of Australia’s big iron ore producers have been beneficiaries of the rising iron ore price which has climbed from $US66 to $US103 a tonne since the start of 2019. BHP and Rio are up 19% and 25%, respectively, but Fortescue has gone gangbusters — it’s up a whopping 107% in 2019!
Whilst BHP and Rio are more diversified in terms of the resources they dig out of the ground, Fortescue is what analysts would call a ‘pure-play’ on iron ore. As a result, the Fortescue share price is highly correlated with the spot price of iron ore. At times like these where the iron ore price is soaring higher, the share price does likewise and everything is rosy.
Volatility
Iron ore is a highly volatile commodity. After reaching a peak of just under $US190 per tonne in 2011 it had sunk below $US40 less than five years later. Attempting to predict its next move is a fool’s game and many have been caught out attempting to do just that. The fact is that there is simply too many variables at play and such predictions are little more than what I would call fanciful guesswork at best.
With such volatility in the underlying iron ore price, Fortescue is a high risk/ high return proposition. If you get the timing right you can make a lot of money. It’s precisely those investors who invest based on their self-proclaimed ability to predict commodity prices that are most at risk. Unfortunately, they may be ignorant of how little they actually know.
Hostage To The Market
In business, Fortescue is what is known as a ‘price taker‘. They have very little control over the price with which they can sell their iron ore. This will be dictated to them by the market at any point in time. The highest-quality businesses have an ability to set their prices and consistently raise prices whilst maintaining market share. As a result they are much more in control of their own destiny than an iron ore producer who’s success will depend much more on the price of a commodity for which it has precious little control over.
Iron Ore Price – Where To Now?
The honest answer is that I don’t have the foggiest idea about iron ore prices.
Analysts will go on predicting the next move in the iron ore price and basic probability will ensure that by chance, some will get it right. They will attribute their ‘lucky guess’ to their skilful analysis and go on making predictions. I have no issue with people predicting what the iron ore price will do next month and buying or selling on the back of such predictions. In fact, it can be a fun pastime. Just don’t turn your nose up at the ‘gambler’ that plays roulette on his Saturday night. Often the only difference between the analyst and the roulette player in that situation is that the roulette player knows he’s gambling.
The Verdict
Given I have no reliable ability to predict the key driver of the Fortescue share price I don’t have an opinion to give on whether right now represents a good time to buy. You could check out the latest analyst forecasts for the direction of the iron ore price before making your decision. Or better yet, flip a coin. The result is likely to be just as valid.
Instead of Fortescue, I would suggest looking for companies that have an ability to make money in all market environments and produce a high return on equity supported by a durable competitive advantage.
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Disclosure: At the time of publishing, Luke has no financial interest in any company mentioned.
