Iron ore, a key steelmaking ingredient, experienced another marginal setback overnight with its price falling to US$120.80 a tonne, its lowest level in seven months. Although this price reflects a 10.5% fall in value since the beginning of the calendar year, a large portion of the market is anticipating it has even further to fall.
While seasonal factors (it is winter in the northern hemisphere, meaning slower Chinese production) make it difficult to determine which direction the price will head from here, many believe it could fall even lower than US$100 a tonne by the year's end, while some have even given it a long-term (real) price between US$80-US$90 a tonne. This can largely be attributed to the declining levels of demand from Asia combined with the increased production from the globe's largest suppliers.
Despite the bleak long-term outlook, it seems there is still value to be realised from the mining sector! For instance, UBS analyst Glyn Lawcock believes Rio Tinto Limited (ASX: RIO) is a 'buy' having set a price target of $90 on the stock – an upside of 35% from today's price of $66.64 – while its dividend distribution is also expected to increase.
However, the issue for me is Rio Tinto's heavy reliance on iron ore as a revenue generator, combined with its enormous debt load. Should iron ore rebound and climb back above US$130 a tonne, Rio could be one of the great beneficiaries, but should it fall rapidly, its ability to repay debts will become less manageable. Fortescue Metals Group Limited (ASX: FMG) is in a very similar boat.
BHP Billiton Limited (ASX: BHP), on the other hand, has taken a much more conservative approach. Although iron ore is still its largest revenue generator, its operations are far more diversified with its "four pillar" strategy, where coal, petroleum and copper are also key focus areas. This means the company would be less susceptible to a further decline in iron ore prices.
While BHP also maintains a high level of debt (at around US$29 billion), the company will strive to reduce that level to under US$25 billion. Management has indicated this would be the time to revisit its capital management initiatives.
A number of analysts have pegged the "Big Australian" to be amongst the better performers over 2014, particularly following on from its disappointing run last year.
Foolish takeaway
Since the beginning of the year, each of the companies mentioned above have declined in value, conceding some of the gains recognised in the second half of 2013. Investors really have three options:
Firstly, you can choose to ignore the temptations of the mining industry altogether, perhaps investing your money in another booming sector such as telecommunications.
Secondly, if you believe iron ore has a brighter future than analysts have forecast, Rio Tinto or Fortescue would be amongst your best bets, while Mount Gibson Iron Limited (ASX: MGX) could also be an attractive alternative.
Thirdly, for investors wanting exposure to the industry, but not wishing to rely too heavily on iron ore, BHP is the best option for you. It is also likely that investors will benefit from increased dividend distributions as well as a potential share buyback program once debt levels fall below US$25 billion.
