Over the long term, I expect iron ore to drop. However, as we stand today, Cliffs Natural Resources (CLF) seems like a decent candidate for a long position. The reason is rather simple as I'll explain.
Cliffs Natural Resources is mostly an iron ore producer, and it's not the lowest cost producer, either. That distinction usually goes to the large Australian producers - Rio Tinto (RIO), BHP Billiton (BHP) and V.A.L.E (VALE), a Brazilian producer. This has severe implications for Cliffs Natural Resources' earnings when iron ore prices are going down, as they were during most of 2012. When that happens, not only is CLF's large dividend seen as being at risk, but the entire company seems shaky. It's thus no surprise that over 2012 CLF got about cut in half as iron ore pricing in China went from as high as $136 per ton during January, down to as low as $86 during August.
During iron ore's quick drop, Cliffs Natural Resources naturally saw its earnings estimates get clipped as well, as we can see below.
Then something happened
Between a renewed stimulus program in China, and then the Fed's printing campaign at a $40 billion per month pace, now increased to $85 billion per month, iron ore prices, as well as steel prices in China, started recovering. And lately, iron ore actually exploded ahead of steel pricing, and with today's gigantic move on prices now sits over $150 per ton. That's higher than it was at the start of 2012, when CLF traded at almost double the present quotes.
And yet …
Even though iron ore rallied all the way above $150 per ton, the consensus earnings estimates for CLF, which I published above, still show no movement from this gain. These estimates were established with iron ore below $120 per ton, and it's highly likely that they'll be revised higher in the following weeks. When this happens, CLF's huge dividend yield - now standing at 6.7% - will seem safe. And obviously, in today's market it won't remain at 6.7% if the market in any way thinks that it is safe, so the market is highly likely to produce a higher stock price for CLF.
Cliffs Natural Resources is hugely sensitive to iron ore pricing, and got murdered when iron ore dropped. Although the stock has already recovered some, it is far from recovering proportionally to the iron ore pricing recovery. Additionally, CLF's earnings estimates still don't reflect any of the iron ore recovery so it's likely that the stock will see higher earnings estimates in the next few weeks. CLF's huge dividend yield and the prospect of higher earnings estimates should be enough to take the stock meaningfully higher than it trades today.
This entire thesis has a short to medium term timeframe. Over the long term I still expect iron ore pricing to go down, but at this point CLF seems like a decent long opportunity.
Disclosure: I am long CLF.