Investors in Australia's iron ore miners have certainly had to remain patient with their investments over the last few years, and while analysts had expected them to be rewarded in 2014, that is now looking less and less likely to be the case.
Overnight, iron ore, which is a key steelmaking ingredient and Australia's primary export product, fell a further US$2.40 to just US$102.70 a tonne – its lowest level in almost 18 months. That figure reflects a drop of nearly 20% over the last four weeks and is roughly 25% below the average the commodity traded at throughout 2013 (at around US$135 a tonne).
The miners themselves have been hit hard as a result. Since the beginning of the year, the industry heavyweights Fortescue Metals Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO) have dropped 15.8% and 10% respectively while BHP Billiton Limited (ASX: BHP), which maintains far more diversified operations, has fallen 2.4%. The smaller miners have fallen even heavier due to their higher costs and lower margins. Mount Gibson Iron Limited (ASX: MGX), Arrium Limited (ASX: ARI) and BC Iron Limited (ASX: BCI) have all plummeted between 22.1% and 36.3%.
Source: Google Finance
Okay, so we all know that the best time to buy a stock is when it has fallen out of the market's favour. While these stocks have most certainly fallen from grace, this unfortunately is not a buying opportunity, but would more likely be a case of 'catching a falling knife'.
Catching a falling knife
For starters, the nature of miners is that they are heavily leveraged to the commodities which they produce. That is, when a commodity's price rises, so does the miner's revenue. The problem is, this applies just as much in reverse, whereby the miner's profits are impacted when the commodity's price comes under pressure. With analysts now predicting the price to drop to as low as US$85 a tonne over the next year, this could well see share prices sink (much) lower.
While each of the miners mentioned above can operate at prices above US$100 a tonne, investors are (justifiably) cautious of their earnings coming under pressure as the price drops below that level. The smaller miners maintain a high break-even price which will mean thinner margins as the price drops. Meanwhile, although the bigger miners (which maintain lower break-even prices) will still make a solid profit on their operations, their profits will still come under pressure.
A safer bet than the iron ore miners
With BHP Billiton Limited as an exception, I have long been bearish on the iron ore sector as supply growth continues to outpace demand growth. Although there is potential for gains in the short-term based on any price fluctuations, I believe there are far better opportunities for you to take advantage of.
