Iron ore officially in bear market

The price of iron ore has officially entered bear market territory, according to Bloomberg. The commodity has lost 20% of its value since its 16-month high of US$158.90 in February. Overnight, iron ore prices slipped a further 1.1% to US$125 a tonne.

Again, it was fears over China’s economic growth and steel production, of which iron ore is a key component, that pushed the price down. Oh, and the fact that large iron ore miners like BHP Billiton (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group (ASX: FMG) have been ramping up supply in recent years.

Rio, in particular, has approved billion dollar infrastructure expansion projects, as it heads toward annual production of 360 million tonnes a year. Fortescue in on track to reach 155 million tonnes in production annually, while BHP is expected to produce 183 million tonnes this financial year.

By 2018, broker Morgan Stanley estimates there will be a 300 million tonne oversupply of iron ore, with a surplus of supply first appearing in 2013. That can only put more downward pressure on the iron ore price.Earlier this year, another broker, UBS predicted the iron ore price would reach US$70 a tonne in the September quarter.

Of course this doesn’t just have consequences for Australian iron ore miners. Iron ore is our largest export, and while volumes are going up, they may not be able to compensate for further falls in the commodity price. That means government revenues are likely to fall, and in a worst case scenario, could push Australia into recession.

Foolish takeaway

The saviour may well be the falling Australian dollar and the Reserve Bank. As the dollar falls against the US dollar, Australia receives higher Australian dollar based prices, resulting in higher income. The Central Bank may also come to the party, by cutting official cash rates even further, forcing the dollar down.

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