The world's hottest hedge fund manager announced a new short position in iron ore that has major implications for the future of the Chinese economy and Canadian equity markets. If iron ore prices are set for a major fall, continued slower growth in China would cripple profit growth for Canadian mining companies.
Greenlight Capital president David Einhorn's investment thesis is a bet against a vastly inefficient Chinese steel producing industry – the end users of iron ore. Spurred by easy credit and a tax policy where local governments benefit from rising output instead of profit growth, China's steel production has increased fivefold since 2000. According to HSBC research, industry capacity is now 200 million tonnes more than demand. The end result was a collapse in steel prices, forcing 68 of the country's steel producers to operate at a loss.
Mr. Einhorn believes that this oversupply of steel, and a sluggish Chinese economic recovery, will see iron ore prices in 2014 fall to below $80 from the current $120 per tonne.
A sustained iron price below $80 would be a severe blow to Canadian iron ore producers. In the Labrador Trough, the Quebec government is steering an $80-billion investment plan to develop iron mines that includes $1.2-billion in government infrastructure development and a potential $5-billion investment in rail capacity. Much of this spending, however, depends on an iron ore price above $100. Companies like Labrador Iron Ore, which is already producing in the region, have halted capital spending plans.
China's dysfunctional steel industry also has negative effects on Canadian companies outside of iron ore miners. Teck Resources' recent profits have taken a beating from the sharp drop in metallurgical coal prices, another primary input in the steelmaking process. Teck's revenue from coal, almost half of the company's total, have declined to $1.1-billion from their third quarter 2011 price of $1.7-billion.
David Einhorn's projections for Chinese steelmakers and the nation's economy are not good news for Canadian investors. But, although Mr. Einhorn has been on a legendary hot streak in the past 18 months – reaping huge profits from short positions in Herbalife International Inc, Green Mountain Coffee Roasters and Chipotle Mexican Grill Inc – no manager is infallible. Greenlight's primary hedge fund lost 3.2 per cent in the second quarter of 2012 because of wrong way bets on General Motors and chemical manufacturer Arkema Inc. Canadians will be hoping Mr. Einhorn's iron ore prediction will prove equally ineffective.
Scott Barlow