The Daily Update - Southern copper, iron ore

Concerns have escalated in the commodity space this morning as Iron Ore in particular could see a dramatic fall in value after it’s nearly 60% rise in price since mid-October last year.

The main reason for this is a huge jump in stockpiles especially in China. Inventories at China’s ports jumped 123.5 million tons last week taking them to about 75% of the ports holding capacity. To put that into perspective it is reported that a further 20 million tons would bring capacity to 90%. The reason cited for this is a massive over calculation in demand by producers combined with suppliers taking advantage of the jump in prices in the fourth quarter of last year. Although demand from China is expected to be flat this year the previous boost to the economy during 2016 did see a period when supply did not meet demand and some say caught the producers on their back foot; chasing to produce as prices were rising. However, Chinese demand has since stabilised, production is already higher than demand with many market analysts forecasting a correction of around 30-50% in Iron Ore as stocks continue to grow.

We have very little exposure to Iron Ore producers and suppliers within our portfolios however, we do have some exposure to copper; through a holding across our global bond funds in Southern Copper Corporation. The US company is headquartered in Phoenix Arizona with mining activity predominantly undertaken in Peru and Chile.

Copper has also rallied since mid-October 2016, up about 24%, much less than Iron Ore and appears to have better fundamentals to support recent prices compared with its runaway cousin. On the back of this our holding in Southern Copper 7.5% maturing July 2035 which is rated BBB/BBB+, has performed extremely well and is one of the few bonds currently trading above the Trump election sell-off back in early November.

Broadly, this bond has rallied nine points since the election and continues to offer attractive risk-adjusted value. Currently trading at a spread of around 300bps off of US Treasuries, this bond remains about 4.3 credit notches cheap against its RVM fair value spread of 145bps and equates to an expected return and yield of 22.3% should it move to fair value. Of course the 5.6% yield is a welcome addition to any portfolio.

We continually search for rotation candidates across our portfolios as some names move faster than others, or indeed individual companies/Government issuers are affected by their own characteristics such as further supply or news affecting profits. However, it is challenging to find a candidate to rotate into from our Southern Copper holding which still offers so much on a risk/reward basis currently.