Investors may have thought yesterday’s $30 billion wiped off our largest iron ore miners market capital was bad, but that might be nothing compared to what might happen in the near future.
Iron ore had already entered a bear market (down 20%) before yesterday, but overnight, iron ore spot prices plunged US$9.40 to US$104.70. BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG) are likely to get smashed in trading today. In early trading, the miners are down 0.9%, 0.7% and 3.9% respectively.
As we warned on February 26, iron ore prices were expected to fall thanks to weaker steel prices, booming supply and huge stockpiles of the commodity at Chinese ports. Add in China’s exports falling 18%, the most since the global financial crisis, and a trade deficit of US$23 billion in February – the first in two years, and the outlook for iron ore isn’t rosy.
As one trader in Shanghai told Reuters yesterday, “Mills are more reluctant to buy iron ore in this situation, and we will see iron ore continue to drop in the next few days. We may break $100 in a very short time.”
For those analysts suggesting Fortescue or Rio were good buys in recent times, it seems they forgot the one vital fact when it comes to resources stocks.
And that is: miners are beholden to the commodity price, over which they have little if any control. To some extent, all three BHP, RIO and Fortescue have tried to overcome the potential for weakness in iron ore prices by ramping up production volumes. But that may well be exacerbating the issue by creating massive oversupply, further pushing the price down.
And if you think the falling prices are an opportunity to pick up shares on the cheap, you might want to remember Motley Fool Share Advisor analyst Scott Phillips’ words on Sky Business yesterday,
“This is not a buying opportunity”.
No matter how far a company’s share price has fallen, in can still go to zero. Now I’m not suggesting that will happen to the three company’s mentioned above, but it’s important to remember that catching a falling knife can be hazardous to your wealth.
The big miners have some of the lowest production costs in the industry so have the ability to survive at much lower prices for longer. But junior iron ore miners like Mount Gibson Iron (ASX: MGX) and Arrium (ASX: ARI) ex-OneSteel could see their iron ore operations running at a loss. There’s only a limited amount of time that they can do that.
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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga