Why Iron Ore Is Going To Be Great In 2013

by: Seth Walters

While America's attention has been firmly fixated on the fiscal cliff, things continue to go on in the outside world. One of those things is that the spot price of iron ore has moved back to $135.50 a ton. A number of things have helped this happen, including Chinese stimulus starting to take effect, cut off exports from India, and various other factors. The bottom line, however, is that iron ore has recovered nicely from its sub $90 lows this summer, as I predicted it would in September. The question is, now that we've climbed back to a fairly high pricing regime, how long are we going to stay here? I think that the answer is actually "for some time yet."

This is going to be counterintuitive to many, because everyone who has followed this issue knows that the supply response for iron ore has been quite strong, and that iron ore firms like Fortescue Metals Group (OTCQX:FSUGY) are currently ramping up very large capacity expansions. But I think that China, despite its recently stated and undoubtedly real desire to push more towards a domestic consumer powered economy, will be forced to resort to significant infrastructure expansion just to maintain an acceptable level of GDP growth. Why? Europe is in recession and could very well get worse. S&P cut the credit rating of Cyprus two notches to CCC+ today, and some have said a default may be imminent. Mario Monti also stepped down as PM of Italy Friday. Elections there are thought to be slated for February 24th, and none other than Silvio Berlusconi seems to be in the running again. He has recently stated he would like Italy to leave the Euro, so a win for him would undoubtedly bring even greater chaos to an already troubled region, and indeed to the world itself. Spain is at Great Depression levels of unemployment (26.2%), the UK's GDP is slipping, and things are just generally not good in Europe. It may be only a matter of time before the Euro gets a bigger hole blown through it than anyone can bail out. In addition to this, well, you all know about the Fiscal Cliff and the issues surrounding our very own debt crisis now. The US is in better shape than Europe on the surface, but we've achieved that by running up massive year after year deficits, and it may be that it is time now to pay the piper. Well... what does this all have to do with China?

China... is not going to be exporting as much next year with most of the developed world in recession. As such, their growth is going to take a good-sized hit if they do nothing. Yet, China needs to maintain a high growth rate to maintain social stability. The logical choice to turn to is yet more infrastructure investment, and they will need more and more iron ore for that. There will be a limit to how much extra infrastructure they will add or how much they will pay for iron ore, but I believe it will be appreciably more than it is now. Goldman Sachs (NYSE:GS) recently put out a price target of $140 on iron ore for 2013. I actually believe that it will be somewhat higher than this - how high depends on a lot of moving parts, but I see healthy iron ore prices next year.

This will be...

Bullish for iron ore producers like Cliffs Natural Resources (NYSE:CLF), Vale (NYSE:VALE), and BHP Billiton (NYSE:BHP)

Slightly bullish for fully integrated steel producers

Slightly bullish for scrap steel producers

Bearish for non integrated steel producers

Bearish for containership companies.

Bullish for drybulk companies operating Capesize vessels. (but the sector is so bad due to overcapacity that it may not matter much)

Bear in mind that just because iron ore stocks have gone down a fair amount doesn't mean they can't go down a lot more before beginning to rise. But, my opinion is that iron ore stocks will beat the S&P 500 in 2013, after it begins to recover from the current dilemma we have. Be sure to do your own due diligence and thinking before making any trade, and always understand there are risks and things may not turn out like you hoped.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.