Iron ore headed back to US$90 a tonne?

Commodity dives 5% overnight, igniting fears of further falls

Investors in iron ore stocks be warned – after the iron ore price fell for a fifth day and suffered its biggest one-day decline in 11 months – iron ore stocks could see their share prices hammered.

Spot iron ore prices fell close to 5% overnight to US$145 a tonne, according to The Steel  Index, on the back of similar falls in steel prices. Steel makers have said that iron ore prices would fall as rapidly as they had risen, as more steel mills cut production in the face of weak demand from customers.

Beginning In September last year, iron ore prices plunged from US$137 a tonne to under US$87 a tonne, in just five weeks, before recovering back to US$160 a tonne by early January.

If the fall continues, we could see Fortescue Metals Group (ASX: FMG) again put its Kings deposit on ice, after the miner announced plans to re-start the development at the end of December, as iron ore prices surged. Shares in Fortescue have rallied 65% as the iron ore price recovered.

Broking houses may be forced to reassess their forecasts for iron ore and the miners– again. JP Morgan raised its first quarter iron ore forecast to US$145 a tonne just yesterday, and lifted its price targets for both Fortescue and BHP Billiton (ASX: BHP) , while also raising its price target for Rio Tinto Limited (ASX: RIO) and upgrading the iron ore giant to ‘overweight’.

The problem for most iron ore miners is the increasing volatility in prices for iron ore. With many miners taking sport or short-term prices for iron ore, they are much more at the mercy of the markets, than if they had stick with longer-term contracts.

In 2008, with the iron ore price approaching US$200 a tonne, BHP chief Marius Kloppers hatched a plan to force Chinese steel mills to accept spot pricing for iron ore, rather than take longer-term contracts at lower prices. With steel prices and iron ore prices now falling, that move may have backfired, and we could see a return to longer-term contracts.

For the smaller miners such as Atlas Iron Limited (ASX: AGO) and Mount Gibson Iron Limited (ASX: MGX), who have higher production costs than the likes of Rio and BHP, further falls in the spot iron ore price could place their businesses under immense pressure. Even Fortescue says it struggles with the iron ore price around US$90 a tonne.

Foolish takeaway

Investing in resources companies – especially those that are exposed to just one or maybe two commodities – highlights the risks associated with businesses that are price takers. Iron ore is iron ore, no matter whether it comes from Australia, Brazil, or Africa, and miners have to accept whatever the market is willing to pay – no matter how low or high it goes.

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Motley Fool writer/analyst Mike King owns shares in BHP. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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