When Falling Prices Don't Matter

09/02/2010 4:44 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

It’s hard to imagine this happening with any other “product”: The price drops 12% for the next quarter, and the stock market essentially shrugs it off.

On a bad day for the market, August 30, when the Standard & Poor’s 500 stock index dropped by 1.47%, the shares of the world’s biggest producer of this product fell by 1.29%.

And on a good day for the market, September 1, when the S&P 500 jumped by 3%, shares of the largest producer rocketed upward by 5.5% and shares of number two went up 6.1%.

I guess when it comes to iron ore—and that’s the “product” in question—investors just don’t expect any price drop to last for very long.

Even after the drop, iron ore prices would be 120% higher than they were a year ago. So, this disappointment would leave these miners still incredibly profitable.

Iron ore prices, which used to be set by annual contract negotiations, are now set quarterly by reference to the price of iron ore on the spot market. The new quarterly price set on September 1 dropped by 12% to $128.50-$130.00 per metric ton, down from $145.00-$147.50 in the current quarter.

The old investing adage—acorns don’t grow to the sky—seems apt here. After more than doubling in a year, it’s only reasonable to expect prices to pull back a bit. The cause of the price drop is a temporary glut in steel that is reducing demand for both iron ore and coking coal.

But judging from the very modest decline (first) and then the huge rally (second) in the shares of BHP Billiton (NYSE: BHP), the world’s largest iron ore producer, and Vale (NYSE: VALE), the world’s second largest producer, no one expects that steel glut or the decline in iron ore prices to last for very long.

Frankly, I’d use any weakness in the sector in the next quarter on this price decline to pick up shares of iron ore and metallurgical coal miners. I mentioned three coal producers in this post that would deserve a look in that scenario. (And it doesn’t hurt that they’re all potential acquisition candidates, too.)

Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.

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