MARKETS SPECTATOR: Iron ore's mid-cap moment

Broker Nomura is expecting the price momentum for iron ore to continue, with Chinese inventory levels the key driver and mid-cap stocks the best value.

Iron ore prices continue to surge, but there are a few indicators pointing towards a slowdown in recent momentum.

In a recent research note from Nomura, they believe that although price momentum remains positive, it’s likely to pause as the Chinese New Year approaches.

"After slowing in early December, there has been a rapid turnaround in iron ore markets with small mills restocking and rising Chinese steel futures. However, into the Chinese New Year, we would not be surprised to see momentum slow, and are looking for the first quarter to average $US130 per tonne”, Nomura noted.

Looking out further, the broker believes there are three positive factors for 2013. Firstly, Chinese port inventories are back to 2009 levels resulting in a low ratio for imports to inventory.

Secondly, Indian mining bans are likely to continue to restrict exports through at least through the first half of 2013.

And, thirdly, slowed growth projects (Fortescue Metals Group and Cliffs) will likely reduce new supply in 2013, keeping the market relatively tight.

Nonetheless, it still believes rapid destocking/restocking events in China will be the main driver of iron ore price volatility, as has been the case in recent years. However, over the past two years most of this activity has concentrated on the second half of the year with inventories at small steel mills falling to 19 days between June 2012 and September 2012 before rebounding to an average of 32 days by year-end.

Interestingly, during 2012 iron equities generally underperformed, especially those in the mid-cap space as funds flowed away from cyclical exposure. Given this and despite the recent strong upside gains seen, the broker believes better value remains in the mid-cap iron ore miner space.

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Nomura’s preferred exposure in the mid-cap space is Atlas Iron, which is rates as a buy recommendation with a target price of $2.25, some 28 per cent above current levels. It also has buy ratings on both Rio Tinto and BHP Billiton with price targets of $70 and $41 respectively.

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