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Iron Ore Stocks & How To Play Them Plus Trading Crude Oil & the VIX Index


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During this week's Invast Insights we cover:
► Australia’s income to take a hit
► How to play the iron ore stocks
► Oil market outlook
► Keep the VIX on your list


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Iron Ore Stocks & How To Play Them Plus Trading Crude Oil & the VIX Index

  1. 1. 1 Week Commencing May 26, 2014
  2. 2. 22 This week we look at the following topics: •Australia’s income to take a hit We look at Australia’s key exports, discuss the impact on imported wealth and terms of trade. •How to play the iron ore stocks Are they a buy at the moment or will the iron ore price continue to fall. •Oil market outlook Some notes to consider if you are watching the oil price and looking for direction. •Keep the VIX on your list An introduction into the volatility index and how to trade it
  3. 3. 33 Australia’s income to take a hit While most of the national conversation in Australia at the moment is around the fiscal budget, many have ignored something far more important. Australia’s two top commodities have seen a slump in their prices and the country is experiencing an effective pay cut. Australia cannot just demand wealth, it needs to earn it. Exports and terms of trade are the best measure of importing that wealth. The mining boom that developed over the past decade helped insulate Australia from many of the problems faced by other developed economies. Is Australia’s luck starting to run out? The chart below shows the top 20 exports made by Australia in dollar terms to the rest of the world last year. Iron ore, coal and gold are the top three. This is very important because Australia’s wealth at this moment, is really generated by exporting services to the world. Domestic productivity needs improvement. Australia needs to capitalise on the huge opportunities in our region. Australia’s small population relative to Asian neighbours means it can only grow by combining capital and skills into the huge population centres.
  4. 4. 44 Source: Department of Foreign Affairs and Trade (Australia)
  5. 5. 55 The iron ore price continues to slide lower, having slumped 6.6% in May and down 26.6% for the year. Australia is expected to export around 690 million tonnes of the raw material this year and so some of the pricing impact will be offset by higher volume, but the trend suggests the country is generating a pay cut on its key commodity. The coal market has also seen prices fall, both thermal and coking coal operations are being reduced along the East Coast of Australia. Gold has stabilized but makes up for a relatively smaller proportion when compared to iron ore. Natural gas will become an important component of the national export market when key LNG projects commence production over the next few years. What Australia needs to see is a stabilization in the iron ore price, some bounce in thermal coal prices and a gradual ramp up in natural gas for the terms of trade to be held in check. We think this is perhaps the most likely outcome, BUT, there is a remote possibility that both iron ore and coal enter into deep bear markets and the ramp up in natural gas takes longer than expected. Energy prices have held up relatively well over the past two years. Our point here is that the national export components need to be watched very closely. Australia is experiencing a pay cut in the goods and services it sells to the rest of the world. This will play into lower government tax receipts and effectively more constraint on the fiscal situation. The government can manage this, debt to GDP is still not a big problem but prudent fiscal management is required to ensure the worst case scenario doesn’t not see a completely disastrous situation on the overall economy.
  6. 6. 66 The budget is a side issue and while politicians will do their best to lobby voters, the national economy is being dragged down by a pay cut which is playing out. The Reserve Bank will find it very difficult to increase rates above emergency levels in this environment and the impact on the A$ will probably mean at cap near current prices against the US$. Unemployment has so far remained contained, but the impact on lower iron ore prices across the rest of the economy cannot be completely ignored. The iron ore and coal markets represent a small fraction of the total employment market, but they represent a large component of our trade data flowing through into government receipts. We think the recent strength in the AUDUSD will start to run out of puff and wouldn’t be surprised if we see the currency pair trending back towards the 90 cent market where it will face a major test. We first published this note on our Invast blog website when the AUDUSD was trading at 0.9327. It has since fallen by 100 pips since the time of writing just a few days after the initial comments. By the time you read this, the AUDUSD could have fallen further. But this shouldn’t matter. Our view is really a medium term view and we think the AUDUSD will continue to struggle to hold ground.
  7. 7. 77 So where to from here? If iron ore and coal prices remain subdued, we could see it draft back and find some long term support in the mid 80 cent range. Some great gains have been made trading the AUDUSD in the first half of this year and a reversal is potentially on the cards for the second half. Prepare yourself and make sure you continue to check out our client only research Invast Insights report for weekly updates on this theme. Image: AUDUSD daily chart approaching Ichimoku cloud level
  8. 8. 88 How to play the iron ore stocks Unless you have been out in the remote Pilbara region of Western Australia, digging dirt and exporting it to China, you would have probably heard that the Iron ore price has been falling. We have discussed above the impact this has on Australia. For those that aren’t familiar with the iron ore market, here are some facts to consider: •Iron (Fe) is one of the most abundant rock-forming elements, constituting about 5% of the Earth's crust. It is the fourth most abundant element after oxygen, silicon and aluminium, and after aluminium, the most abundant and widely distributed metal. Iron is indispensable to modern civilisation and people have been skilled in its use for more than 3,000 years. However, its use only became widespread in the 14th century, when smelting furnaces (the forerunner of blast furnaces) began to replace forges. •Most of the world's important iron ore resources occur in iron-rich sedimentary rocks known as banded iron formations (BIFs) which are almost exclusively of Precambrian age. In the Hamersley Province in the Pilbara district of Western Australia there are three main types of deposit: iron oxide enrichments within BIFs; iron oxides deposited along ancient, mainly Tertiary age river channels (palaeochannels); and iron oxide deposits formed from the erosion of existing orebodies (detrital iron ore deposits). •Although iron ore resources occur in all the Australian States and Territories, almost 93% of identified resources (totalling 64 billion tonnes) occur in Western Australia, including almost 80% in the Hamersley Province, one of the world's major iron ore provinces. In 2009 Australia's economic demonstrated resources (i.e. those that have been sufficiently tested by drilling and that could be economically extracted at current prices with existing technology) totalled 28 billion tonnes and ranked Australia second (with 17%) behind the Ukraine (18%). •Australian iron ore is not only attractive from a geological perspective but also in terms of geography. Its close proximity to Chinese ports adds a freight advantage. China imported 83.39 million tonnes of iron ore in April this year, the second highest monthly figure on record and up 12.8% from March, driven by seasonal demand from Chinese steel mills for the raw material. The April rise in iron ore imports was driven by high production rates at Chinese steel mills over the month, caused by a pick-up in seasonal demand, although slower-than-expected growth had dragged rebar prices down by 3% in April, the fifth consecutive monthly loss.
  9. 9. 99 China is by no surprise the largest steel manufacturing country in the world and by a very large factor. We estimate China manufactured 779 million tonnes of steel in 2013. This accounts for around 48.5% of total global steel manufacturing capacity. The European Union in its entirety produced 165 million tonnes last year and Japan – despite having one of the most developed steel production facilities in the globe – produced only 110 million tonnes. The world superpower – USA – produced 87 million tonnes. What happens in China matters immensely to where the iron ore price goes and where Australian iron ore earnings print.
  10. 10. 1010 They key Australian iron ore producers are:
  11. 11. 1111 We like to be contrarian but we also don’t like fighting the market when there is an overwhelming theme to the downside. There is an opportunity here to start adding iron ore stocks to a very well diversified portfolio if you believe in the China growth story continuing. We don’t hold any iron ore stocks in our three monthly portfolios, but that doesn’t mean we won’t add them in the future when they start to meet our portfolio characteristics. We would weight our holdings to the stocks which have suffered the largest annualised falls over the past three years – Atlas Iron stands out as a stock which has been hammered…probably on justified concerns but it still is a business that is generating reasonable positive cashflow. Mount Gibson is another name that stands out, it has a very large cash backing per share unlikely the majors who tend to have debt on their balance sheet. We would balance out the position with BHP – the highest quality name in the space. So a typical allocation to iron ore, as a contrarian play, might see 25% into Atlas Iron, 25% into Mount Gibson and 50% into BHP. We see no immediate reason to go into Rio Tinto which is stuck somewhere in the middle between the biggest loser and high quality. We wouldn’t suggest allocating more than 10% of an overall portfolio to iron ore. So assuming a $100, 000 portfolio – our allocations would be $2,500 to Atlas Iron, $2,500 to Mount Gibson and $5,000 to BHP Biliton.
  12. 12. 1212 Oil market outlook We’re starting to get more and more bullish on the oil price. We have maintained an overall positive outlook since the beginning of the year. In our 2014 forecast guide, we wrote the following “One of the greatest assumptions out there in the market is that growth in US energy production will reach levels which will see it become completely energy self-sufficient. We think many forecasts in the market around this theme are overly ambitious. The United States is the world’s largest consumer of oil and by a very large factor, it has a strong vested interest in putting a lid on oil prices particularly as its economy emerges from a deep downturn. The last thing the United States would want is its economic growth momentum to stall given all the money printing and fiscal stimulus which has been pumped in.“ We went on further to say “US energy production growth is serious but one of the things we watch closely is the amount of US supply in terms of stockpiles. We don’t buy into the myth that the US could become a major energy exporter in the next decade. The data just doesn’t back this assumption up. Oil supply in the US is sitting at around the same run rate as it has been over the past decade despite a large increase in domestic energy production. The charts below are sourced from the US Energy Information Administration.”
  13. 13. 1313 We plan to expand on this theme in the coming weeks and months. The more literature we read, the more bullish we become on oil prices. There is a huge difference out there between US energy independence and US oil independence. These are often incorrectly confused. Energy independence is a conversation around all sources of energy – mainly focused on the huge natural gas boom in the United States. We don’t discredit this at all. BUT! The US is nowhere near becoming independent in terms of its oil consumption and the eventual squeeze on the oil market is starting to develop as we write. A few of the reasons why we are starting to become even more bullish on the oil price. •As contrarians, we look at what many in the market are assuming. There is an overwhelming view out there that oil prices are set to fall in the coming years due to the myth of US becoming independent in terms of its own consumption. There aren’t many investment houses in the market expecting the oil price to explode. We find this interesting given the fact that the Brent crude price has now booked its longest winning streak in history, consistently sitting above US$100 per barrel for the past few years. •Out of 192 new highs on the New York Stock Exchange in the last week of April, around 52 were energy companies. The S&P Oil and Gas Exploration and Production Index SPDR (XOP) recently broke out of its narrow trading range. This is an important event because energy companies have lagged the run up in oil price for the past few years. In Australia, Woodside Petroleum has recently broken through new highs and continue to charge its way into the mid $40 per share range. It wasn’t too long ago that Woodside was struggling to rise above the low $30 per share range. •The Middle East and North Africa has never looked more fragile. Recall that OPEC and the former Soviet Union account for almost 60% of global oil production and 80% of global stated revenues. The situation in Syria continues to deteriorate with no resolution in sight, Libya continues to struggle from its civil war, Iraq recently held elections which are unlikely to deliver any material change to the deep wounds which have opened up over the past decade and relations between the Unites States and Saudi Arabia have never been worse. To us it appears less stable than any time in recent memory. Bombing continue in Nigeria where oil theft remains a huge problem. We haven’t even touched on Russia yet and its geopolitical struggle with Western Europe.
  14. 14. 1414 We plan to go through all of these topics in the coming weeks and months, our analysis will pinpoint each problem area and quantify what this means for oil demand and supply. We will use the latest and most up to date statistics to show how volatile the current oil market really us. We will also use the same rational to break the myth that oil supply is rising the world’s super powers are no longer dependent on supply from these volatile regions. Until then, we suggest you start accumulating positions in the Brent crude price through our Invast MT4 trading platform. Below is a chart showing the performance of Brent crude futures. There seems to be some resistance at the current US$110-112 per barrel level which if broken could set the stage for a retest of the US$115 per barrel range. Any subsequent breakout above this level will see much large further upside. It is becoming hard to contain our excitement around this prospect. We are major oil bulls at this point in time. Imagine: Brent crude futures four hourly chart via Invast MT4 platform
  15. 15. 1515 Keep the VIX on your list The VIX index is an interesting trading instrument, we also quote this on our Invast MT4 platform. VIX is a popular measure of the implied volatility of S&P 500 index options. The calculation can be academic at times, there is plenty of literature online that explains how the index is actually calculated. We plan to only run through the key points and what we believe is the trading opportunity. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period. The VIX is quoted in percentage points and translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, which is then annualized. For example, if the VIX is 15, this represents an expected annualized change of 15% over the next 30 days. With US markets scaling all time high levels and further gains on the S&P500 looking fairly capped, we think the VIX index represents reasonably good risk/reward characteristics at current levels. The way of thinking around this trade is very similar to our call on the EURUSD a month ago where we said Draghi would need to act and set a ceiling at the 1.4000 level. Since then, we have seen the Euro come back to the 1.3650 range area.
  16. 16. 1616 Image: VIX futures hourly chart as quoted on Invast MT4 platform
  17. 17. 1717 The VIX can spike significantly when fear grips the market. It’s a very volatile instrument but doesn’t seem to be pricing in any fear in the market at the time being. Recent history has shown as the market is most at risk when complacency builds in. The Black Swan by author Nassim Taleb is a fantastic book about unexpected, unpredictable events and the impact they have on fragile organisms, like the stock market for example. Buying the VIX could be a complete waste of time, a difficult trade to predict and timing can really work against you. But when that unexpected even does come to fruition, the market will respond and the VIX will be the most immediate beneficiary. We don’t know the time and exact situation in which the VIX will increase but we believe on a risk/reward basis the trade deserves to be on your radar as a trader. Below is a longer term chart which shows previous spikes on the VIX. Keep in mind the current spot price as of the time of writing is around 13. Image: Data and chart via CBOE data
  18. 18. 1818 Did you see the NEW ST24 video? After months of development, tweaking and a number of beta testers, Invast Australia is proud to announce the launch of the ST24 Forex systems trading platform. Here are some statistics you may find interesting: •Launched in Japan in 2011 •Over 60,000 accounts in the first 2 years •Choose from over 6,000 Forex trading strategies •One of the World's largest auto-trading services •Proprietary risk management system called the Margin Meter To see why ST24 has boomed in popularity in such a short space of time, jump over to our short 90 second video overview by CLICKING HERE or on the image below.
  19. 19. 1919 Need more information on how you can get started with ST24? Get in touch with one of the friendly Invast team today on 1800 468 278 or use the live chat facility at or email and we'll help you out.
  20. 20. 2020 Go to to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.
  21. 21. 2121 Disclaimer Please note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us. General Disclaimer: This newsletter contains confidential information and is intended only for the person who downloaded it. You should not disseminate, distribute or copy this newsletter. Invast does not accept liability for any errors or omissions in the contents of this newsletter which arise as a result of downloading this newsletter. This newsletter is provided for informational purposes and should not be construed as a solicitation or offer to buy or sell any financial product. Invast Financial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).
  22. 22. 2222 Risk Warning: It's important for you to read and consider the relevant Product Disclosure Statement, and any other relevant Invast Financial Services Pty Ltd documents before you decide whether or not to acquire any financial products listed in this email. Our Financial Services Guide contains details of our fees and charges. All these documents are available here on our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange are leveraged products and carry a high level of risk and you can lose more than your initial deposit so you should ensure CFD and Foreign Exchange trading meets your personal circumstances. General Advice Warning: Being general advice, this newsletter does not take account of your objectives, financial situation or needs. Before acting on this general advice you should therefore consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision.
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