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Iron Ore Rally Means Think Again About Miners, China


Why should you care that iron ore costs more now than it did in 2007? Because its price is a meaningful proxy for manufacturing dynamism around the world.

The price of iron ore is rallying sharply. It has risen by 15% since June and nearly 50% from a low last September. Iron ore costs more now than it did in 2007.

Why should you care? Because iron ore is the primary raw material needed to make steel, and steel is the primary material needed to build buildings and cars, among other bedrock economic drivers. So prices for iron ore and its still more ubiquitous cousin copper are meaningful proxies for manufacturing dynamism around the world, and particularly in China, the great making-things engine of our age.

It has been a rough few years for these proxies. Iron and copper both peaked in early 2011 along with the pace of Chinese economic growth. Since then both metals have gotten about 30% cheaper on world markets, and turned into evidence for a now-established market narrative: The age of a burgeoning China driving high commodity prices is over. China, where the Shanghai Stock Exchange Composite Index has also lost one-third of its value, has stumbled, afflicted by plagues of smog, banking shenanigans, and who knows what else. The future belongs again to the USA and companies that live on brainpower.

The rally in iron ore indicates that this big story line may be shifting again. Whatever existential challenges confront semi-Communist China, its huge financial reserves still enable its leaders to step on the economic accelerator pretty much at will by upping spending on the country's vast infrastructure campaign.

That is apparently just what happened in the first half of this year. Chinese steel production increased by 7.45%. At the same time, world iron ore prices slumped to $110 per ton, a point where imports became cheaper than products of Chinese domestic suppliers. The inevitable result: China's iron imports rebounded to a record 73 million tons in July, a strapping 26% jump from a year earlier. Prices have snapped back to some $130 per ton.

Can the market keep tightening? China's bosses seem to think so, considering that they are trying to jawbone iron ore prices down rather than calmly waiting for them to subside on their own. Chinese prime minister Li Keqiang personally told Andrew Mackenzie, chief executive of iron mining power BHP Billiton (NYSE:BHP), that Beijing is looking for lower costs, Mackenzie lately told an Australian newspaper. The miners are in no mood to deal, though, judging by the response of Sam Walsh, CEO at rival Rio Tinto (NYSE:RIO). Producers have "heard similar commentary from China since iron ore was discovered," the plainspoken Aussie boss fired back.

Signs of a recovery in copper are more tentative. The retail investor's most common window into the "professor of metals," the iPath Dow Jones-UBS Copper Subindex Total Return ETN (NYSEARCA:JJC), has bounced up about 8% over the past six weeks, but still remains one-third (a fraction that is becoming eerily familiar) off of its 2011 highs. Copper did have its best week in a year last week, gaining more than 4% on – what else? – Chinese manufacturing growth, which accelerated to a robust 9.7% in July. The country's copper imports increased by 12% year-on-year last month.

The most obvious response to the two essential metals' signs of life is to take another look at battered miners' stocks. Rio Tinto and BHP, the No. 2 and 3 iron producers in the world, have both already rebounded by 20% over the last month, but remain nearly 20% down year-to-date. Top producer Vale (NYSE:VALE), which adds the perceived risk of its native Brazil to iron price risk, has been more volatile – dropping 27% since Jan. 1, but regaining 25% during the recent upturn.

The traded company that comes closest to a pure copper play is Freeport McMoRan Copper & Gold (NYSE:FCX), the No. 2 global producer after Chile's state-owned Codelco. Freeport, which also mines gold, is trading at half of its 2011 peak and has barely begun to creep back. So if you believe copper is on the mend, there are gains to be made there.

In broader terms, the movements in iron ore and copper – not to mention oil, which has also climbed by some 10% since mid-June – tell us that financial markets are still challenged to soberly evaluate the rise of China and its tremendous centrifugal pull on commodities prices among other things.

In 2010-11, investors were gripped by the vision that China could keep growing at close to double digits indefinitely and would soon displace the US as the world's hegemonic power. That swung over the past two years to speculation that the miracle would prove illusory, and China, in some unforeseen fashion, would crash back to the stone age.

It is clear by now that the reality is somewhere in between. Investors who can get China at least sort-of right stand to gain handsomely.
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