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Is there a bright future for iron ore?

Calendar year 2013 was a pretty great year for iron miners, with some meteoric rises of up to 70% and more on the back of strong iron prices, and the strength in iron miners looks set to continue into 2014.

That said, I’ve just sold half of my iron ore shareholdings in BC Iron (ASX: BCI) and Rio Tinto (ASX: RIO).

A massive global increase in supply has me nervous about the five-year future of iron prices, and thus the profitability of these miners. Local companies BHP Billiton (ASX: BHP), Fortescue Metals (ASX: FMG) and Rio Tinto are all greatly expanding their output, with Rio to increase its production by 35% in the next three years and the other miners following suit. Brazil’s Vale Mining (NYSE: VALE), the world’s largest iron ore miner, plans to increase capacity by 50% to 450 million tonnes by 2018.

If you factor in smaller Australian (and foreign) miners increasing production and new mines being established – I’m thinking Gina Rinehart’s $10 billion, 55Mtpa Roy Hill mine here – the stage is set for an oversupply in global iron ore that will subdue prices. Vale Mining issued a similar statement recently in which it expects some surplus capacity as early as 2015, with 5-6% oversupply to occur in 2018. An oversupply of 5-6% is still considered a ‘tight’ market, and period undersupply may occur in the event of bad weather or other incidents affecting production. Vale predicts that iron ore prices will remain above $100/tonne; however the peak prices seen this year ‘are unlikely to happen again’. I might point out that even $100 a tonne is still some 24% lower than today’s prices.

Large companies such as Rio, Vale and BHP can weather prices at this level; however a drop of $30/tonne may place considerable earnings pressure on smaller miners. Any changes shouldn’t filter through the market until at least 2015, so there is no immediate rush to sell your iron shares. In these matters I believe it’s better to move early ‘in expectation of’ rather than ‘in reaction to’ change.

Foolish takeaway

I was fairly heavy on iron ore in 2013, so selling half my portfolio reduces my exposure and allows me to redirect money towards companies I perceive as greener pastures, such as Woolworths (ASX: WOW) and Westfield Group (ASX: WDC). If you hold iron shares – particularly in junior miners – I would suggest you at least consider doing the same. If you’ve enjoyed large rises in your iron portfolio this year, you could sell a number of shares equal to the profit you’ve made and redirect that money elsewhere, whilst still owning iron shares equivalent to the dollar value you initially invested.

If you are rebalancing your portfolio, Rio Tinto, BC Iron and Fortescue Metals are a good way to achieve direct iron ore exposure, whilst BHP has a lot more diversification and should protect your money better from any strong iron ore downturns.

 

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Motley Fool contributor Sean O’Neill owns shares in BC Iron, Rio Tinto and Westfield Group.

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