Iron ore rallies to 3-month high

The iron ore price closed last week at a three-month high of US$133 per tonne, which marks nearly 12 months since iron ore was in the midst of its falls to its September 2012 low of US$87 a tonne. Helping support the price was last week’s trade data out of China which was much stronger than expected coupled with iron ore inventory levels at the lower end of the scale.

The strong iron ore price has helped a number of iron ore producers hit three-month share highs as well. For investors who think the iron ore market has stabilised and that the sell-off of miners within the sector may have been overdone, here are three miners that offer investors exposure to iron ore, are also amongst the lowest cost producers, are structuring their businesses around production volumes rather than high prices and could be worth a closer look.

Rio Tinto (ASX: RIO) is ramping up production of iron ore. This positions the company to benefit should the iron ore price remain high and also provides some protection should the iron ore price decline. By September this year, management is expecting to begin cycling an expanded annual capacity of 290 million tonnes per annum from the Pilbara.

In comparison Fortescue Metals Group (ASX: FMG) shipped 90.9 million tonnes in the 12 months to June 2013 which was 41% up on the prior 12-month period. Management’s near-term production output aim is to achieve a rate of 155 million tonnes per annum by December this year which should significantly improve the average cost of production.

Meanwhile the much smaller producer BC Iron (ASX: BCI) of which Fortescue is now a 25% shareholder in the Nullagine Iron Ore Joint Venture has recently achieved a production rate of 6 million tonnes per annum and appears to be tracking well. In December BC Iron upped its stake in the JV from 50% to 75%; the company also continues to pay down debt and is producing solid cash flows.

Before investors get too carried away that iron ore above $100 is a sure thing and jump in to buy beaten up iron ore miners, one highly regarded analyst Mr Tom Price from investment firm UBS sounds a word of caution worthy of investors’ attention. According to a report in the Australian Financial Review, Mr Price believes “the iron ore price would soon begin to suffer as steel mills began their seasonal habit of reducing production at the end of the northern summer, and that meant another big iron ore price crash could be imminent.”

Just how much of a crash in prices does Mr Price envisage? He doesn’t think US$70 is out of the question.

Foolish takeaway

It’s important to remember how hard it is to predict commodity prices and also to remember that many mining projects would not be viable at historical iron ore price levels. For these reasons, focussing on the lowest cost producers and the strongest balance sheets is vitally important.

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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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