While the U.S. is fixated on whether Congress will shoot the country in the foot, a few giant companies on the other side of the world are raking in the profits. Times are so good for the iron ore industry that the industry's results are carrying Australia's 3% GDP growth. There are big winners and big losers in this market, but the best opportunities aren't where you'd think. Read on and I'll explain why a few small companies are better for your portfolio than any of the large mining giants.
The winners
As the worldwide economy has recovered from the debt crisis of 2008, demand for iron ore from steelmakers in China has surged. Since supply is relatively constrained in the short term -- it takes years for new iron ore mines to be built -- iron ore prices have jumped roughly threefold since 2008. This is enough on its own to send miners' profits soaring, and it has.
This morning, Vale
There is a second factor that has played into miners' booming profits.
The losers
In 2008, shippers were making money hand over fist as there was a shortage of ships to move iron ore and other goods. Shippers were charging rates that peaked at $234,000 a day for a Capesize vessel, which carries roughly 80,000 to 175,000 dead weight tons (DWT). Many companies rushed to build ships. This had its expected effect; the past two years saw the Capesize fleet grow 39 percent, to 1,115 vessels.
Now there's an oversupply of ships and rates are at their lowest levels in years. A Capesize costs just $11,314 a day to charter, a 95% drop from three years ago and below most companies' breakeven points. Shipping costs now take up just 10% of the value of iron ore, down from a high of 64% in 2003. This has increased miners' profits as lower shipping costs mean more money from sales goes straight into their pockets. It's a dream come true for iron ore miners, the highest prices in years with the lowest freight prices.
However, it's a nightmare for shippers. Currently the spare carrying capacity of the Capesize fleet is roughly 25%. The nightmare is going to get worse. There are still more ships being built. IHS Fairplay estimates new orders are equal to 36% of existing capacity. The only way this makes sense is that companies like Dryships
Where to invest?
After that diatribe you'd probably expect me to recommend a mining company, right? Wrong.
Remember the secret to commodities investing:
The time to own commodities is when they are down, when everybody has lost money in them, and when they trade below the cost of production.
In times like this you should be looking for value among the shippers rather than the mining companies. The reason is that when a commodity is unprofitable for the companies that provide it, high-cost providers die off or halt operations. This is true whether we are talking about shipping, iron ore, natural gas, or ethanol. The industry shrinks as the weakest firms die off. This time is marked by large amounts of turmoil, falling stock prices, and occasionally bankruptcies before supplies decline and prices rise again. The companies that do survive thrive as the industry begins to do better, and that's where the best profits can be made.
What do I like now?
While DryShips is intriguing, unless you are willing to take a huge gamble, I'd avoid it. While the company will survive, shareholders might see more massive dilution before it thrives once again.
The stock I like most is Diana Shipping
And struggle they will. As a recent Goldman Sachs report noted, the shipping business is getting tougher with faster growing supply and less demand for shipping in the first quarter than expected. Highly leveraged operators such as Eagle Bulk Shipping
Foolish bottom line
When looking to invest in a commodity, focus on commodities trading below the cost of production, and over time you should be duly rewarded. Looking for more ideas? Check out The Motley Fool's free report "The Only Energy Stock You'll Ever Need." Just click here to grab a copy.
