When the price of a stock, currency or commodity appears to be in free fall, traders often say you “shouldn’t catch a falling knife”.
It’s an adage that sprang to mind reading a bullish note from Kieran Berry, private client advisor at Shaw Stockbroking, on iron ore and Fortescue Metals.
Berry himself admits he might be trying to catch that falling knife. But he argues “from a risk reward perspective that buying some beaten up resource stocks could we worthwhile at current prices”.
Berry says that at current prices “three in every four tonnes of iron ore produced globally is now at or near loss making” levels.
He notes that while Atlas Iron this week has sought time to restructure and review via a share suspension, other “high cost producers are now coming under pressure” as well. His list includes Arrium Ltd (ARI), BC Iron Limited (BCI) and Mount Gibson Iron (MGX), all of whom UBS data suggests have breakeven production costs which are under water at current prices.
Berry likes the low cost producers “such as BHP Billiton Limited (BHP), Rio Tinto Limited (RIO) and to a lesser extent Fortescue Metals Group (FMG)” which he says look attractive at current levels.
But it’s Fortescue metals, which last night closed at $1.94 up 15 cents from the recent lows, that looks “the most overdone at present”.
What’s really driving Berry’s enthusiasm for Fortescue though, to use another trading adage, is that he believes all the bad news is “baked in the cake” at the moment. That is, “weak commodity prices are largely factored into the share prices of our favourite resource stocks”.
Essentially, Berry is saying that these weak prices will heal themselves because supply will exit and prices will gradually start rising again. That will take Frtescue higher.
But he does have a warning – “if weak iron ore prices persist longer than expected (12 months)” then all bets are off.