Fortescue Leads Junk Miners to Best From Worst: Australia Credit

Junk bonds from Australian miners went to best from worst last month, as Fortescue Metals Group Ltd. rallied the most in a year after mining bans in India and improvement in China’s economy pushed up iron-ore prices.

The debt handed investors a 4.2 percent return in December, the best among six nationalities in the Bank of America Merrill Lynch U.S. High Yield Metals & Mining index. The notes gained 2.1 percent in the five months ended Nov. 30, the worst performance. Fortescue’s notes climbed 4.5 percent last month, the best performance since January 2012, the data show.

Iron ore, Australia’s biggest export, has rebounded 83 percent since slumping to a three-year low in September. The plunge forced Fortescue to seek $5 billion in new loans to lower debt costs. Since then, China boosted spending on subways, sewers and roads and carried out a leadership transition, easing fears of a sudden end to the mining boom that helped Australia evade recession for more than two decades.

“Sentiment has improved as everyone feels less grief and concern about the new government in China,” Tom Price, a Sydney-based commodity analyst at UBS AG, said by phone. “The demand side looks stable, there’s no macro constraint. The big shock on ore trade will probably relate to the supply side -- cyclones are one, India is definitely a factor running at 50 percent normal capacity.”

Indian Ban

India’s Supreme Court has banned iron ore production at 93 mines in Goa after a probe found that mining had contaminated ground water and led to illegal logging. The ruling has helped shore up prices at a time of year when demand typically strengthens. Exports from Australia’s Pilbara region, where Fortescue, BHP Billiton Ltd. and Rio Tinto Group operate iron-ore mines, are susceptible to disruptions from cyclones, which typically hit during November to April.

A gauge of China’s manufacturing activity released Jan. 1 showed a third month of expansion, adding to evidence that the recovery in the world’s second-biggest economy will extend into the new year. The Purchasing Managers’ Index was 50.6 in December, while a reading above 50 indicates expansion. The report reflects increased infrastructure spending that’s helping drive a rebound from a seven-quarter slowdown as a new generation of Communist Party leaders takes the nation’s reins.

China Recovery

“The normal seasonal restocking of raw material feeding into the steel industry will become most active from Chinese New Year though to about the middle of this year,” said Price, referring to the Lunar New Year holidays around Feb. 10. “Cyclone season in the Pilbara will have some impact, there could be shock impacts on the delivery of ore to Asia. What’s probably going to have a much bigger impact is India.”

Australia’s Bureau of Meteorology is tracking cyclone Narelle, which may become a severe tropical cyclone as it moves towards coastal areas where Port Hedland, the world’s biggest iron-ore port, is located.

India exported 33.1 million tons in the first 11 months, for a 4.9 percent market share of China’s imports, down from 11 percent in 2011 and 21 percent in 2007, according to data compiled by Bloomberg

Iron ore for delivery to China’s Tianjin port jumped 31 percent over the past month to $158.50 per metric ton, the highest level since October 2011, according to The Steel Index Ltd. The rally has spurred a drop in Australian government bonds and prompted traders to reduce bets that the central bank will drop interest rates to a record this quarter.

Yields Rising

Benchmark 10-year yields rose to a 4 1/2-month high of 3.47 percent on Jan. 7, and were at 3.40 percent as of 12:25 p.m. in Sydney, or 154 basis points higher than similar-dated U.S. Treasuries.

Traders see a 37 percent probability the Reserve Bank will reduce the benchmark rate to 2.75 percent at its next board meeting on Feb. 5, down from a 59 percent chance on Dec. 31, according to interest-rate swaps data compiled by Bloomberg.

Bond investors are favoring Fortescue’s high-yield bonds after the miner cut costs with $5 billion in new loans that helped to extend its maturity profile, with the first debt not maturing until 2015.

The extra yield investors demand to hold Fortescue’s $1.5 billion of November 2019 notes rather than similar-dated Treasuries shrank to 552 basis points on Jan. 8, the lowest since May, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority. The premium reached a record 810 on Sept. 6.

Kings Deposit

Australia’s third-biggest iron ore exporter said last month it’s resuming work on the Kings deposit as commodity prices rose, after putting the new mine on hold following the September price plunge. A potential plan to sell part of its rail infrastructure could fetch more than $4 billion, Michael Evans, a resources analyst with CIMB Securities (Australia) Ltd., said last month.

“Higher iron ore prices are driving Fortescue’s bond performance,” Ben Byrne, credit sector specialist at Citigroup Inc. in Sydney, said by phone. “The other factor is their secured loan they negotiated in September, which improved their liquidity. The infrastructure asset sales that they’re looking at will also potentially improve their liquidity, should they occur.”

Investing Cash

Fortescue and other high-yield mining bond issuers are also benefiting from investors allocating cash at the start of the new year.

“In the current credit environment, a lot of cash needs to be put to work in the new year,” Chris Walter, a Sydney-based credit research analyst at Westpac Banking Corp., said by phone. “There is a large number of investors looking to get their money to work.”

Iron ore’s recovery -- while expected to cool from levels above $155 a ton to average $120 a ton during the quarter -- has left producers on surer footing and boosted earnings forecasts.

“The return to a more-normalized, high-price environment is likely to place iron-ore producers on a more positive footing,” Nomura Holdings Inc. analysts David Radclyffe and David Cotterell wrote in a Jan. 7 report.

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