Mining Stock Bears Get Paid as Iron-Ore Rebound Halted


JANUARY 15, 2015

Options traders who bet against a rebound in Australian iron-ore stocks are being proven right.

Contracts that pay out should Fortescue Metals Group fall 10 percent have gained 80 percent since demand for bearish wagers pushed a measure of option costs to the highest in three years compared with bullish ones last week. The company’s shares have slumped 18 percent since Jan. 6, erasing a 19 percent rebound from a mid-December low. Fortescue is the most shorted stock on the S&P/ASX 200 Index, according to Markit Group data. Bearish bets on Atlas Iron are more than four times the gauge’s average.

Iron-ore prices rallied as much as 7 percent from a five-year low reached last month, driving gains in stocks from Fortescue to Atlas Iron and BC Iron amid efforts by China to speed up $1.1 trillion of infrastructure projects. The steelmaking material has since resumed its decline, sinking 4.3 percent in four days.

“We were due a bit of a rally from oversold conditions, but that’s really just a short-term bounce,” Shane Oliver, head of investment strategy at AMP Capital Investors, which oversees more than $127 billion, said by phone from Sydney. “Sooner or later you’ll see some blow ups” among companies, he said.

The Bloomberg Commodity Index of 22 energy, agriculture and metal prices plunged to a 12-year low this week as oversupply spurred a rout in oil and as slowing economic growth in China and Europe reduced demand for raw materials such as copper. The commodity index has fallen since 2011, paring gains from the first decade of the 2000s. Citigroup and Goldman Sachs Group have said the era of rising prices is over.

Supply, demand

Vale, Rio Tinto Group and BHP Billiton, the world’s top producers of iron ore, last year increased output and expanded a market glut just as growth in China slowed. Ore with 62 percent content delivered to Qingdao, China, slumped 47 percent in 2014 and fell to as low as $66.84 a dry metric ton on Dec. 23, the least since June 2009, according to Metal Bulletin. It retreated 0.6 percent to $68.30 on Wednesday.

Atlas Iron slumped 86 percent last year before soaring 67 percent in the first four trading days of 2015. It’s retreated 26 percent since then. BC Iron has followed the same pattern, plunging 90 percent in 2014, rebounding 36 percent then sinking 22 percent.

Iron ore is now trading below break-even levels for Atlas Iron, according to Goldman Sachs analyst Owen Birrell, who has advised selling the Perth-based producer of the material since August.

Making money

“We’re still a long way from levels where companies with the higher cost structures can actually make money,” Matthew Sherwood, Sydney-based head of investment markets research at Perpetual, which has about $21 billion in funds under management, said by phone. “Companies with a high cost structure like Fortescue will continue to struggle given the high debt that it has on its balance sheet.”

Fortescue has $8.8 billion of bonds and loans outstanding, according to data compiled by Bloomberg. Bearish three-month options on its shares on Jan. 6 were 11.4 points more expensive than contracts betting on a 10 percent rally, the highest level for the ratio known as skew in three years, according to data compiled by Bloomberg. The skew surged to a fresh three-year high of 12 on Wednesday.

Put options expiring in March that give the holder the right to sell Fortescue shares at A$2.10, or 10 percent below on Wednesday’s close, soared 44 percent to 18 Australian cents on Wednesday, taking their gain since Jan. 6 to 80 percent. Bearish February contracts with a strike price of A$2.30 rose 63 percent to 19.5 cents on Wednesday. Investors held 1.39 put options for each call on Jan. 13, the data show.

Short selling

Perth-based Fortescue has 21 percent of its freely available shares sold short, according to data compiled by Markit as of Jan. 13. That’s the most among the 200 companies on Australia’s benchmark equity index. Short interest comprised some 16 percent of Atlas Iron shares compared with an average of 3.5 percent on the S&P/ASX 200.

Spokesmen for the commodity companies — Byron Vale at Fortescue, Paul Armstrong at Atlas Iron and James Harris at BC Iron — declined to comment.

The premier of Western Australia, Colin Barnett, told the state parliament in October that some small producers may close with the loss of hundreds, if not thousands, of jobs.

The prospect of more stimulus in China may offer some respite. Asia’s biggest economy is accelerating 300 infrastructure projects valued at 7 trillion yuan ($1.1 trillion) this year as policy makers seek to shore up growth that’s in danger of slipping below 7 percent, people familiar with the matter said this month.

Easing speculation

China’s industrial profits fell the most in two years in November, a report showed last month, signaling a deepening economic slowdown and increasing pressure on the People’s Bank of China to follow up November’s surprise interest-rate cut with further monetary easing.

“We may be about to see more easing coming from the PBOC, so that will stand those iron-ore miners in pretty good stead,” said Ben Le Brun, a Sydney-based market analyst at OptionsXpress Australia, a unit of Charles Schwab, which trades futures and options.“The rally we’ve seen in the early part of 2015 has probably been a symptom of short covering.”

The World Bank cut its global growth outlook this week, citing weak expansions in Europe and China. Energy and materials shares have led losses this year on a gauge of Asian equities.

“It’s a bit too early to be picking up mining stocks,” said Hans Goetti, Singapore-based head of investment for Asia at Banque Internationale a Luxembourg, which has about $36 billion in assets. “The global economy isn’t doing very well, with growth in China and Europe slowing.”