Fortescue Metals Group (ASX: FMG) (OTCQX: FSUMF) shares should track, with some lag, the performance of the Chinese construction industry. This might sound a little odd, that an iron ore miner in Australia should have its value determined by who is building apartments several thousand miles away. But that is how this part of the modern economy works. The health of China’s property industry is the single biggest factor at play here.
The link is that the Pilbara iron ore deposits are the richest on the planet. Purest material, in such vast quantities, in an environment where really all that’s required to extract is a digger and a rail line to the port. OK, slightly more complex than that but not all that much. How to do this is well known, as Rio Tinto and others show every day. Fortescue is among them. But where that iron ore goes to is, by and large, China. Turn out that building civilisation 1.0 sucks in vast amounts of iron and steel, that means lots and lots of iron ore.
Sure, there are other deposits closer to hand. But they tend to be of lower grade ores like magnetite. The preference is for that good quality Pilbara production.
Fortescue Metals Group share price from Google Finance
That’s what gives us that Fortescue share price pattern there. As May turned into June everyone was getting more worried about the health of the China Property market. Would the government allow swathes of it to go bust. It was obvious that it was all in terrible trouble, but would they actually allow widespread bankruptcies? If so that would reduce iron ore demand and thus the iron ore price. And then there was policy support for that construction industry. This is what drove up the price of China property companies like Country Garden of course. “Country Garden Services (HKG: 6098) (OTCPK: CTRGF) shares jumped 25% today. There was a significant rise in many China related shares but Country Garden stood out even among the real estate ones. The Hang Seng was up 3%, but many of those China related property ones 10% and more.” Policy support for property will do that in a managed economy like China’s.
The background issue here is that Fortescue is a commodity producer. To an economist this means that they can’t influence the price at which they sell - that’s set externally by the market. The market for Australian shipped iron ore is largely China - at least that’s the price bellwether. So, Fortescue’s profits depend upon the China property market. Note that this isn’t exactly and wholly true but it is largely so. By far the biggest influence over time is going to be what’s that delivered China iron ore price? Which will be, largely enough, determined by the marginal customer, the Chinese property market.