Iron ore price to remain strong, but for how long?

In recent months, Australia’s iron ore miners and bullish resources investors have enjoyed the benefits of a resilient spot price of the steelmaking ingredient. Miners have welcomed higher revenues and margins whilst shareholders have received strong returns in share prices.

Although many analysts and research houses believed the price of iron ore was certain to drop as a result of the Chinese economy slowing and iron ore supply increasing, it hasn’t. Australia’s biggest iron ore miners, which offer high grades and low costs per tonne, thanks to their economies of scale, have risen well.

Rio Tinto (ASX: RIO), BHP Billiton (ASX: BHP), Fortescue Metals (ASX: FMG) and smaller miners like BC Iron (ASX: BCI) have each notched up impressive share price gains. Despite the gains, many remain convinced the high iron ore price is something investors and miners can get used to – at least in the short term.

Baosteel, China’s biggest steelmaker, believes the high price is likely to continue in the short term as mills restock into the New Year. According to The Australian, “State-owned Baosteel told UBS analysts in China last week that steel demand had met or beaten expectations.”

As a result of the high demand, iron ore imports are expected to show impressive production growth in 2013, up 7% on last year. However maintaining such high iron ore prices in the long term is doubtful. “Baosteel still believes the long-run iron ore price outlook is down but concedes that, in the short run, prices may remain high,” UBS said.

Foolish takeaway

It’s so hard to predict long-term iron ore prices accurately because so many factors come into play. However basic economics dictates that a rise in supply without an equivalent increase in demand will put downwards pressure on the price of iron ore. Supply is certainly increasing; the question is whether or not demand will follow.

Uncertainty lingers over the spending on infrastructure projects by the Chinese government, which has spurred on a massive demand for steel in recent years.

Despite China’s huge manufacturing base and rising middle class, which will fuel a continued need for steel and iron ore, Australia’s Bureau of Resource and Energy Economics believe the price of iron ore will average just $US 91 per tonne by 2018 – a far cry from their current levels above $US 130 per tonne. However it should be noted that our bigger low cost producers will still be viable at those reduced levels.

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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