Contrarians: Gold and Iron Ore Are Calling

• Ray Dalio knows how to make a buck!
• Callum puts his neck on the line
• Plus, see when gold shines best…

Callum Newman

Dear Reader,

1. Let’s begin the week by discussing billionaire hedge fund manager Ray Dalio. Why so? I picked up his 2015 book Principles the other day at the library.

I didn’t walk in there with it in mind.

I just saw it on the shelf…and ended up reading it over the weekend. I highlighted this bit early on in the book…

‘To make money in the markets, one needs to be an independent thinker who bets against the consensus and is right. That’s because the consensus view is baked into the price.’

That’s our mission here at The Daily Reckoning Australia. We have an ongoing example right in front of us, too: the outlook for iron ore.

For several months now, I’ve touched on this thematic.

None of the investment banks foresaw it going over US$200 at the start of the year. But there it demonstrably sits right now for the high-grade stuff.

And yet still, I don’t feel the full impact of this has ‘rerated’ the sector in a commensurate manner.

That’s why this quarter is so important. Most analysts had the second half of 2021 pegged as the period when iron ore ran out of steam.

The longer it stays high, the more pressure builds to rerate the shares higher.

Last week, I also saw some data that suggests the price could stay higher for longer than the consensus expects.

What was it?

Aussie exports!

An analyst at Westpac reported the following…

‘If May iron ore export volumes fell short of our expectations, then June exports really disappointed.

‘After just 76mt in May, exports in June fell to 73.2mt according to our shipping activity models. That's -10%yy and -6%3myy.

‘Given recent price gains and the weather-based drag on exports in Q1, we had expected to see a stronger rebound in Q2. That clearly was not the case.’

As we so often hear in financial markets, it’s supply and demand that drives prices.

Demand is roaring for the moment, but supply is not forthcoming — yet, anyway — to really cool down the market.

I tuned in to Barry FitzGerald’s explorers podcast the other day, and one of the gents he interviewed made the point that, in regards to iron ore, it was the supply component that analysts generally overestimated.

It’s hard to convey how wrong some of these forecasts have been.

For example, since at least 2019, the ‘boffins’ at the Australian Treasury had iron ore pegged at US$55 a tonne for an age before they looked out the window and noticed the price was way beyond their ridiculous underestimate.

Naturally, working for the government, there was no penalty for their uselessness and probably a promotion for making the government’s budget management look impressive. 

Who’s holding any of them accountable? No one, as far as I know.

However, pity the poor fools who cued off their guidance to run their investment portfolio.

Right now, Fortescue Metals Group Ltd [ASX:FMG] and Rio Tinto Ltd [ASX:RIO] trade on grossed-up yields of 15.4% and 14%, respectively.

Part of this reflects the consensus view that iron ore should drop from about now. That brings us back to Ray Dalio.

The consensus may be right. If I’m wrong, I’m wrong.

But you’re only going to make decent money if you bet against the consensus.

My analysis says iron ore is a contrarian bet worth taking.

We can apply this same line of thinking to gold…

2. Last year around July, I warned my subscribers away from gold stocks. I’m glad I did.

At one point in ‘FY21’, the Aussie gold index fell 30%. It closed on 30 June down about 20%.

But I see the dynamic for a run-up in the gold sector this financial year.

I started buying and recommending gold stocks in March.

As is usually the case, when prices are down, and it seems a bit risky, it’s harder to get anyone interested.

Gold stocks rallied but then pulled back. That leaves a delicate balance in the works.

Here’s my simple observation: gold does best when ‘real’ interest rates are negative.

That means to take the nominal yield on a long bond, say 2%, and subtract the inflation rate, say 3%. That means, in this hypothetical scenario, ‘real’ rates are -1%.

And they are negative right now.

Let’s look at some history on this from the US…

The shaded areas in this chart show you when rates went negative. You can see gold rise in these periods.

Here’s another point worth noting. Inflationary pressure in the economy is known to suppress price-to-earnings ratios.

A lot of gold miners — and iron ore stocks — trade on modest multiples.

That adds another compelling element to the trade, in my view.

With these factors in mind, I urge you to consider investing in gold stocks now. I am.

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia