Fortescue stock could be ready for a classic short squeeze

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Extreme bearishness surrounding iron ore is receding. Key drivers include BHP’s (largely symbolic) move to defer its iron ore infrastructure spend, and a growing realisation that central authorities in China mean what they say about maintaining GDP growth at 7%.

This change in market sentiment was evident at yesterday’s release of the China manufacturing flash PMI. At 49.2, it disappointed expectations of a read at 49.6, and suggests ongoing (modest) contraction in China manufacturing. Normally, this would knock iron ore prices for six. Instead, iron ore continued its recent rally as traders focused on the potential for further PBoC stimulus:

This is the iron ore price (62%) in CNY traded on the Dalian futures exchange. Note the move back over 400 yuan. This looks like a reversal, and may indicate significant further gains to come.

Fortescue Metals (FMG) this week issued 2.3 billion in bonds, replacing all the debt maturing until 2019. The short position, as reported by ASIC, is around 11.7% of issued stock. Bearing in mind that around 50% of the stock is held by interests associated with chair Andrew Forrest, this means around one quarter of the tradeable stock is now short sold. In my view, the conditions are now ripe for a short squeeze:

Even a 50% retracement of the fall over the last 12 months would see FMG’s share price roughly double to $4. This may take months or years to play out, but a short squeeze could see the first part of any up move occur very rapidly.

This post originally appeared on CMC Markets Analysts Blog. You can follow CMC Markets on Twitter.

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