Iron ore succumbs to downward pressure

Although iron ore increased by US60c to US$131.70 per tonne going into Friday, it seems that the commodity may finally be succumbing to slight downwards pressure.

The key ingredient in steel manufacturing has been sitting around the US$140 per tonne mark for some time but has recently taken a slight step back. This week, it has dropped by nearly 3% and there are many factors that suggest it could have further to fall.

Firstly, the third quarter has traditionally been a weaker period for iron ore as Chinese steel mills destock their reserves as they move into winter. Meanwhile, companies such as BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG) – along with international corporations – have been expanding their production rates. More supply coupled with less demand will drag the price down towards equilibrium.

Another large indicator however, is the soft steel prices. Whilst the price of iron ore and steel normally move in sync with the other, this hasn’t been the case in recent times. As such, it is expected that the price tag on iron ore will fall to meet that of steel. Pengana head of global resources, Ric Ronge, said “It’s easier to see the iron ore price coming down to match what’s been foretold by the steel prices, as opposed to steel prices rising to justify iron ore prices.”

This week, RBC upgraded its forecast to US$120 per tonne as the average iron ore price for 2014.

Foolish takeaway

Each of the iron ore miners have rallied in recent months as the price tag on the commodity has shown resilience around the US$140 per tonne mark, however, should the price continue to fall we can expect that investors will once again begin to lose confidence in the miners. As such, it may be a safer bet to avoid investing in these companies, or at least waiting until they fall in price considerably before pressing the ‘buy’ button.

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

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