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Ore-struck - Short-term thinking can pervade all aspects of business and investment

07/02/2013

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

The day after Boxing Day is not traditionally a busy time for company news but 27 December 2012 was when Fortescue metals group, a large Australian business whose website proclaims it “the new force in iron ore”, chose to announce it would be resuming a multi-million-dollar development it had mothballed just three months earlier.

The company had decided to defer this project in September 2012 in response to what it described as “volatile market conditions”, which might reasonably be taken as including the significant drop in the iron ore price over much of the preceding year. Since Fortescue’s initial decision however, the price has enjoyed a very significant spike, bouncing back to close to its previous peak.

 iron ore price history

For a very long time, as the above chart shows, iron ore traded steadily at around $20 (£12.40) a ton before the mining boom eventually pushed the price up above $160. After Fortescue decided to invest in its new development, the price fell back below $100 a ton, leading to the company putting things on ice. The subsequent bounce back above $140 has led to the project being back on once more.

This feels odd because mines tend to have lifetimes of 20 or 30 years or even more. To ensure they produce a return, mining companies obviously need to take account of the price of whatever they are mining but it should be in the context of the coming decades not months. Fortescue’s decision-making suggests either the long-term price of iron ore is being affected by its short-term price or the economics of this particular project only work if high iron ore prices allow windfall gains in the short term.

Seemingly this is a multi-million-dollar investment decision based on the current price of iron ore – even though, as the above chart shows, its average price over the last 20 years would be less than half that. As such, it a striking illustration of how, in an industry where capital decisions should be made on decade-long horizons, the tail can often wag the dog – and why mining is such a cyclical business.

Even so, it would be unfair to pick on Fortescue and its directors when across the board – and even though they know they should not – investors are becoming increasingly short-term in their outlook. This sort of mentality pervades across business and investment and is obviously what we are looking to the disciplines of value investing to help us avoid.

 

Author

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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