Iron ore's golden carrot

PORTFOLIO POINT: Iron ore stocks have been dumped, but there’s value in gold – especially on an Australian-dollar basis.

The best investment decisions in August were to sell iron ore stocks and buy gold, as Eureka Report suggested in separate reports on August 8 and 17 – and there should be more of the same in September.

Selling iron ore stocks (Iron ore crush, August 17) before the sharp correction of the past week saved money.

Buying gold (Rushing to gold, August 8) made money, thanks to the unique role of the metal as a currency and commodity.

Three trends which produced the August investment result will continue as the latest bout of economic uncertainty washes around the world.

Those trends are:

• Flat, or falling, prices for industrial metals as the major economies of Europe, the US and China struggle to maintain growth.
• A strong, or rising gold price, as investors seek safety ahead of more monetary easing, and because of concern that South Africa’s gold industry will be hit by industrial action that started in the platinum sector.
• Weakness in the Australian dollar as the country’s declining terms of trade, exacerbated by falling iron ore and coal prices, cause international investors to review their exposure to the currency (and country).

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The situation with iron ore stocks has been well reported by others since we pointed out that the “real” price received by Australian miners had dipped below $100 a tonne – weeks before that fact was widely acknowledged.

Today, the “real” price being received by most Australian iron ore miners has dropped to around $75 a tonne, and perhaps less after impurity discounts, tipping some high-cost producers into the red.

What’s happened with iron ore is that the US dollar price most widely quoted is not what many (if any) Australian miners get, because that price is for 62% iron content in the ore whereas the Australian average if around 57%, and because of discounts applied for impurities such as phosphorous, silica and alumina, which must be removed by steel mills.

Back on August 17, when the 62% iron ore price was $US113.50, the “real” Australian price was around $94 – and the share prices of producers had started to decline. Fortescue Metals was down to $4.13, Atlas Iron was at $1.84, Mt Gibson at 98c, Gindalbie at 43c, Grange at 40c, and Iron Ore Holdings at 99c.

Today, Fortescue is trading around $3.54 (down 14% in two weeks), Atlas is at $1.32 (down 28%), Mt Gibson is at 74c (down 25%), Gindalbie is at 34c (down 21%), Grange is at 29c (down 27.5%), and Iron Ore Holdings is at 85c (down 14%).

There are forecasts of an iron ore price recovery in the final quarter of the year, after the current bout of de-stocking by Chinese steel mills ends. But, by the time that point is reached the mills will be in a position to drive very hard pricing bargains.

Tempting as it might be to buy fallen iron ore stocksit might be best to wait until there is evidence of a sustained price recovery, with the 62% iron ore price moving back above $US110 a tonne, to be confident that the smaller miners have returned to profitability.

Gold is a different story, benefitting from global uncertainty, industrial strife in the world’s fifth-biggest gold producer (and one-time biggest) South Africa, and for Australian investors from the currency effect.

What’s happened recently with gold is a reminder of something I’ve been writing about for years – always have some gold in your portfolio because of its counter-cyclical behaviour.

Over August, as the All Ordinaries index on the ASX rose by 1.1% (and lost that modest gain in today’s trade), the gold index rose by 4.4%, almost precisely in line with the US dollar gold price, which gained 4.1% to $US1690 an ounce.

On conversion to Australian dollars the gold picture looks even brighter – and will continue to improve as the value of the Australian dollar slides under terms of trade pressure.

The August 1 opening US gold price of $US1622/oz boiled down to an Australian gold price of $1544, using the Reserve Bank’s official exchange rate on the day of $US1.05.

Today, with the exchange rate down to $US1.026, and the US gold price up to $US1690/oz, the Australian gold price is $1647/oz – a gain of $103/oz, or 6.7%.

The August gold example, using a combination of the rising US price and the falling Australian dollar, made gold one of the best (if not the best) investments over August.

Looking ahead, there is every reason to assume that the gold/currency effect will continue, thanks to growing external pressures on the Australian dollar.

If, for example the gold price reaches $US1700/oz and stays there, and the Australian dollar slips back to US90c, the Australian gold price will rise to $1888, a notional gain of 14.6%.

Risks abound, as they always do with gold, and the best way of treating it is as a counter-cyclical insurance policy against troubles in other areas of the global economy – of which there are plenty.

And, if proof is needed that gold has reverted to its currency role, it’s worth looking at activity among gold stocks on the ASX last week, especially those favoured by overseas (particularly British investors) – where a dash for the exit was on display.

Middle ranking gold stocks such as Medusa, Kingsrose, Troy and Resolute all retreated, even as the gold price rose in all currencies.

At work was the reverse currency effect – international investors quitting Australian gold stocks because of the exposure they represent to a currency widely expected to retreat over the next six-to-12 months.

What that means is that the best exposure to gold is gold itself, either through an exchange-traded fund, or by playing absolutely safe through ownership of the metal.

Australian gold equities, especially those widely held by foreign investors, will come under pressure as negative publicity builds around the Australian economy.

With gold, currency giveth for Australian investors, and taketh away for British and American investors.