Iron ore to fall to US$100 – what should you do?

Iron ore, a key steelmaking ingredient, fell a further 2% overnight to a fresh six-month low of US$124.80 a tonne and analysts believe there is still more pain to be felt.

While miners of the commodity continue to ramp up their production levels, supply growth is pegged to exceed demand growth, which will apply a downward pressure on its price.

In fact, it is predicted that it will keep on falling towards the US$100 a tonne mark this year, while even further declines are possible going into 2015. While it is already down around US$10 a tonne this year alone, Goldman Sachs believes it will continue falling to as low as US$108 a tonne this year, while US$80 a tonne could be the price next year. From today’s price, that resembles what is almost a 36% downside for the commodity.

Not surprisingly, this is not good news for Australia’s blue chip miners with BHP Billiton Limited  (ASX: BHP), Rio Tinto Limited  (ASX: RIO) and Fortescue Metals Group Limited  (ASX: FMG) all having fallen due to iron ore’s plunge in value. Rio is down 1.7% today after falling 1% on Tuesday, while Fortescue, which is a pure iron ore play, is down 3.1% after losing 4.6% yesterday. Meanwhile, Mount Gibson Iron Limited (ASX: MGX) has conceded 2.8% and Arrium Limited (ASX: ARI) has dropped 1.8%.

What should investors make of these numbers?

If iron ore continues its freefall, profits are going to be heavily affected and it may also become more difficult for companies such as Fortescue to pay off their enormous debts.

There are really three ways investors can go with this. Firstly, they can listen to the analysts and ignore the lure of iron ore miners altogether – perhaps investing in the healthcare industry instead. Secondly, they can take the risk while shares have fallen, picking up companies such as Fortescue at a heavy discount to the price they were trading at just last week. Or thirdly, they could go somewhere in between by investing in a company such as BHP.

Although iron ore remains BHP’s primary revenue generator, it maintains much more diversified operations than its peers and is thus a less risky investment case.

Foolish takeaway

Unfortunately, there is absolutely no way of knowing if these pessimistic forecasts will play out. After all, analysts had also predicted heavy falls in the commodity throughout 2013, which never transpired, instead, it remained resilient at around US$130 a tonne for the year.

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

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