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BHP, Rio nervous with iron ore prices set to drop

Iron ore is expected to succumb to heavy price volatility as global supply begins to outweigh demand.

If the price of iron ore drops dramatically, we are likely to see less volatility in the mid to long term because only our largest and cheapest producing miners will be able to be sustainable for an extended period of time.

Alan Chirgwin, General Manager of iron ore marketing for BHP Billiton (ASX: BHP) said new seaborne cargoes will gradually displace more expensive output, particularly in China. This is ringing alarm bells for some of our smaller miners, which rely heavily on continuing Chinese demand to remain competitive.

Last week, Wang Liqun, deputy secretary-general of China Iron & Steel Association, announced that although Chinese iron ore imports grew last year, this year they are expected to drop considerably. “Significant low-cost supply, mainly from Australia and Brazil, will eventually meet and exceed incremental Chinese demand”.

BHP is reliant on its iron ore business, with over 34% of the overall company’s revenue currently coming from the division. Rio Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG) rely upon it even more, at 47.7% and 100% respectively. In addition, Fortescue’s current revenue comes almost entirely from China.

Despite the poor outlook for the commodity globally and tough conditions locally, the big miners have seen their share price rally in recent weeks. Fortescue’s share price increased over 12% last week alone – perhaps expected price volatility is already being felt.

Foolish takeaway

The S&P/ASX 200 (ASX: XJO) (^AXJO) has rallied in recent months, fuelled by dividend seeking investors who also want the safety net of a large, reputable Australian company. BHP, Rio and Fortescue are amongst the cheapest of Australia’s biggest listed stocks and offer healthy dividends. Keep an eye on the price of iron ore and remember there are still bargains to be found in the industry.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, 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. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Owen Raszkiewicz owns shares in Rio Tinto.

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