Will China keep buying ore what?

Much has been made of China’s shunning of Australian exports. But what about iron ore? It’s hitherto been assumed that the Middle Kingdom is too reliant on Australia’s high quality iron ore for its steel-making needs and therefore would be reluctant to stop purchasing it.

Australia is the top iron ore exporter and China relies on it for 60 per cent of its supply.

With that in mind, Morningstar’s Peter Warnes offered a compelling counterargument this week and suggests investors in Australia’s iron ore producers may wish to trim their holdings. China’s steel production has soared in the past five years, which leads Warnes to believe it may be stockpiling.  

“I postulate China may be setting a trap for Australia and our iron ore producers,” Warnes writes. “The current production rate is equivalent to enough steel to build 52 Sydney Harbour Bridges per day, one every half hour!”

Until now, Australia’s iron ore trade with China is considered safe, particularly since the number two supplier, Brazil’s Vale, is struggling to deliver. But do we risk being complacent? Consider this for instance: “China has already singled out Brazil as a preferred country for any Chinese-developed COVID-19 vaccine,” Warnes says. “Could China be stockpiling steel and buying time while it vaccinates Brazil and Vale back into the iron ore supply chain?”

The table below indicates the current Morningstar valuations for Fortescue, BHP, Rio Tinto and Brazil’s Vale. Some characteristics jump out: a lack of competitive advantage; high to very high uncertainty; and swollen price-to-fair value ratios.

Source: Morningstar Direct; data as at 18 December 2020

And this exhibit on the past five years of performance is also one to consider. Fortescue Metals Group has returned more than 1000 per cent; BHP almost 140 per cent and Rio Tinto more than 150 per cent.

Fortescue Metals Group (FMG), BHP (BHP), Rio Tinto (RIO) – growth of $10,000 over five years

Source: Morningstar Premium; data as at 18 December 2020

“While all iron ore producers will report very buoyant earnings for the period ended 31 December and are bursting with fully franked dividends, a 10 per cent pull-back in share price could erase any near-term dividend,” Warnes says.

“As a precaution, I suggest prudent investors should take some money off the table. The timing of such action, if my proposition has any validity, is difficult to predict, but Chinese New Year on 12 February ushers in the Year of the Ox and could prove opportune. All food for thought.”

In Firstlinks this week, Graham Hand features a free ebook of 20 favourite interviews conducted with market experts across a wide range of asset classes and investment styles. A great Christmas read. He also examines ETFs, the outlook for 2021, reviews where super policies are headed, and includes some fresh investment ideas.

Hand also sits down with Evan Reedman, head of product at Vanguard, who describes the success of ETFs and how his company decides which products to launch.

Speaking of Vanguard, it now has the world's first $1 trillion stock fund. We look back at how the landscape among the largest funds has changed.

Elsewhere, we survey the thoughts of several local asset managers and their thoughts and investment ideas for 2021. Infrastructure, healthcare, building supplies, and job-seeking sites are worth a look, they argue.

The health sector in particular is tipped to outperform in 2021. Morningstar analysts say Australian names such as CSL and ResMed are set to benefit, writes Nicki Bourlioufas.

'Tis also the season for increased consumer spending. With markets at all-time highs and less travel, many consumers will splurge on consumer goods during this retail holiday season, says Morningstar’s Dave Sekera.

It’s been a big year for new listings. Morningstar Canada’s Andrew Willis rakes over the 10 biggest IPOs of the year—launches that took on the pandemic, raised billions and introduced some of the most exciting opportunities.

Not all are worth jumping on, however. Airbnb is a case in point and investors should resist booking an investment in this advantaged travel operator, says Morningstar analyst Dan Wasiolek.

Locally, it was a rough year for some of Australia’s biggest companies as covid took its toll and low rates inflated asset prices. Here we check the 11 wide moat stocks under Morningstar Australia coverage to see how they performed.

At the other end of the spectrum are the companies with no moat and high to very high uncertainty—otherwise known as the stocks on Santa’s naughty list. Susan Dziubinski does some finger pointing.

James Gard turns the focus back to China. It shrugged off covid before everyone else and its sharemarket has shone. Will it continue?

It’s also that time of year where we sit down with Peter Warnes to discuss his Forecast for the year to come.

And as Christmas approaches, tune in to our latest podcast, Christmas Gift Ideas for Investors. In it, Mark Lamonica and Shani Jayamanne toss around a few gift ideas you could give an investor, from the novice to the expert. Included in the podcast stocking are investments with low minimums, three names on Morningstar’s December Global Best Ideas List, and some books to boost your knowledge.

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing.