The iron ore see-saw swings back

Junior iron ore miners could get hit today, after spot price sinks below US$60 per tonne overnight

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Overnight the spot price of iron ore fell 3.2% to sink to US$59.35 a tonne.

It seems this time the price fell because of forecast for higher Australian exports of the raw material, mostly used in steel making.

It's the first time the price has dropped below US$60 per tonne in five weeks according to reports. According to Australia's Department of Industry and Science, Australia is set to export 824 million tonnes of iron ore in 2016, up 10% on this year. The department also cut its average price of iron ore to U$54 a tonne, from US$60 a tonne it was predicting in March.

Rising exports from Australia and Brazil are compounded by weakening demand for Chinese steel, creating further imbalances in the supply and demand curve. China is the major consumer of world trade in iron ore, accounting for around 69%, but the country's GDP growth is slowing, driven by a weak property sector, falling exports and weak industrial output.

The department says China's steel production is estimated to have contracted by 0.4% in the first four months of 2015, and forecast to fall by 1.5% for the year.

World steel consumption is barely growing, and expected to reach 1.6 billion tonnes this year, before rising 1.7% to 1.64 billion tonnes in 2016. At the same time, exports of iron ore from the major world producers looks something like this.

Source: Company reports
Source: Company reports

 

Clearly iron ore production is growing much faster than demand, which in simple economics means the price will fall further, and the odds of seeing the US dollar iron ore price with a 3 in front of it aren't a silly as you might imagine. The commodity hit a low of US$42.30 per tonne in early April, and it wouldn't be at all surprising to see that reached this year.

Higher-cost producers are being forced out of the market, and in May the Secretary General of China's Metallurgical Mines Association reported that domestic iron ore output is expected to fall by 60 million tonnes this year.

No wonder then that the profitability of Chinese steel mills is in question and the country is searching for ultra-low cost, high-quality iron ore. A deal with Brazil's Vale will give them that as I outlined in late May, while also reducing China's dependence on our two iron ore giants Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP).

Hancock Prospecting's Roy Hill mine is expected to be a low-cost, high-quality producer and will add a further 55 million tonnes to the supply side. Lower prices are unlikely to have a major impact on Rio, BHP and Hancock given they will continue to drive their production costs down even further.

The problem this causes is that lower quality, higher cost producers such as Fortescue Metals Group Limited (ASX: FMG), BC Iron Limited (ASX: BCI), Atlas Iron Limited (ASX: AGO) and Mount Gibson Iron Limited (ASX: MGX) are being squeezed out. Further price falls will pressure the juniors even more, and the outlook is not good as I wrote here for Fairfax Media.

Foolish takeaway

While a punt on these miners might work out, the risks are exceptionally high, particularly for those with large debts, such as Atlas and Fortescue. I'll remind readers of Warren Buffett's number one rule of investing again – "Never lose money'.

Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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