Bet against David Einhorn on iron ore

Did the hedge fund legend make a rare misstep with his bearish stance?

By Benzinga Jan 24, 2013 5:18PM
Nuts and Bolts copyright Andrew Bret Wallis, Photodisc, Getty ImagesBy The ETF Professor 

It is now widely known that hedge fund legend David Einhorn is bearish on iron ore producers.

If Einhorn's comments to that effect in October 2012 didn't convince investors, then Greenlight Capital's letter to clients issued earlier this week should do the trick.


In the letter, Greenlight says it holds a bearish view of iron ore equities and that is has "shorted a number of stocks in the sector." 


Without knowing exactly which iron ore stocks Greenlight is short and when those positions were initiated, grading the success of Greenlight's trades is difficult.


What is known is that Einhorn spoke bearishly about iron ore and steel companies as far back as October 2012, and if he opted back then to short stocks such as BHP Billiton (BHP) and Vale (VALE), the world's largest iron producer, there is a good chance those trades are not going in his favor.


The reason is that the Chinese economy has started to take a turn for the better, causing iron ore prices to surge. While there is no exchange-traded product backed by iron ore futures, there are plenty that hold stocks such as BHP and Vale. Investors can use some of the following funds to bet on high iron ore prices, while potentially profiting from what could be a rare misstep by Einhorn.


iShares S&P Global Materials Sector Index Fund (MXI): Vale, BHP and Rio Tinto (RIO) are the world's three largest iron ore producers and that trio combined make up almost 18% of MXI's weight. That gives this exchange-traded fund (ETF) plenty of exposure to increasing demand and prices for the commodity used in the production of steel.


The resurgent Chinese economy has been a boon for MXI as the fund has gained over 8% in the past 90 days. However, investors need to note exactly what they are getting involved with here as this ETF is about much more than iron ore production.


MXI is also home to chemicals producers such as DuPont (DD) and Dow Chemical (DOW) along with fertilizer names such as Potash (POT).


Those factors are not the big sticking points with MXI, though. MXI's issue that investors need to be cautious of is exposure to gold miners, one of the more uncooperative sub-segments of the materials universe. In the past three months, the Market Vectors Gold Miners ETF (GDX) is off almost 12.5%.


MXI's exposure to pure-play gold miners is not significant enough to make this ETF a loser as iron ore prices rise, but the fund's exposure to gold-mining equities is enough to mute MXI's upside.


iShares MSCI Australia Index Fund (EWA): A predictable choice given that Australia is one of the world's largest iron ore-producing countries and that China is Australia's largest trading partner.


BHP, EWA's largest holding, and Rio Tinto together make up over 15% of EWA's weight. Both are diversified mining companies, but both are also highly dependent on iron ore as a revenue and profit driver.


In 2011 iron ore accounted for 42% of BHP's profits, as the Chicago Tribune reported. In the same year, Rio Tinto derived nearly half its revenue from iron ore production, according to SeekingAlpha.


Global X China Materials ETF (CHIM): China is often perceived as the primary destination for imported iron ore, but it must be noted the world's second-largest economy is looking to reduce its dependence on imports by increasing the proportion of domestic iron ore to 45% by 2015. 


China is already the world's largest steel producer, so its efforts to increase domestic iron ore production make sense, particularly at a time when prices are rising. Morgan Stanley expects iron prices to average $133 per ton this year and that China will increase shipments 12%, according to Bloomberg.


CHIM is small (just $2.8 million in assets under management) and its average daily volume is less than 4,800 shares. On the other hand, the ETF has surged 15.5% in the past three months, outperforming the iShares FTSE China 25 Index Fund (FXI) by nearly 400 basis points along the way.


For more from Benzinga on ETFs, see here.


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