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Spotlight on Fortescue

The generally agreed-upon definition of a bear market is a drop of 20%. With the price of spot iron ore dropping 29% from a recent 12-month high of $160 in February to just US$112 last week, iron ore could now well and truly be considered to have entered bear market territory.

Being forward looking as the stock market is, this has already been priced into many iron ore companies’ share price. As the chart below shows, the speedy decline in iron ore prices since February has been met by a thumping crash in the value of mining stocks. While the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is up nearly 1% over the four months to May, Fortescue Metals Group (ASX: FMG) is down nearly 30%, Atlas Iron (ASX: AGO) is down around 48% and Mount Gibson Iron (ASX: MGX) has fallen 41%.

For investors in miners such as Fortescue the key question is, at what iron ore price is the company profitable? Once investors have determined the cost of extraction they must then forecast the iron ore price going forward. The current volatility makes this extremely difficult.

Australia’s wealthiest person, Gina Rinehart, must also have some concerns around her significant exposure to iron ore. The Australian Financial Review reports that Ms Rinehart is looking to diversify her interests and exposure away from iron ore, with a source suggesting that her privately held company Hancock Prospecting is looking to explore opportunities for mining copper in Peru.

FortescueChart

Source: Google Finance

Foolish takeaway

The boom in commodity prices was caused by a booming Chinese economy. With reports that China may be growing at closer to 5.5%, than 7.5% coupled with reports of excessive supplies of steal and scrap, it is hard to have much confidence that commodity prices and miners will rebound any time soon.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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