3 things every iron ore investor should know

The fall in the iron ore price is creating havoc for investors, as company valuations are re-adjusted downwards ,to take into account lower realised commodity prices. For example in the past 3 months the share price of Fortescue Metals Group Limited (ASX: FMG) has fallen 17.5%, BC Iron Limited (ASX: BCI) has fallen 26.6%, Mount Gibson Iron Limited (ASX: MGX) has lost 33%, and Atlas Iron Limited (ASX: AGO) has dropped 29.2%.

The drop in prices is bound to lure some punters to buy, however before investors jump in, here are three things they should know:

1.       China’s demand for steel is slowing

It’s no secret that the Chinese government has been stimulating their economy by encouraging the (over)building of both residential apartments and infrastructure projects. Recent data provided by China’s National Bureau of Statistics suggests that new property construction fell 25.2% over the first quarter of 2014 and that home prices fell 7.7% too. With the residential property market accounting for 24% of China’s steel consumption – this is a massive red flag for investors.

2.       The Treasury department is forecasting iron ore to fall below $90/tonne

Weaker demand from China can really on mean one thing – lower prices!

  3.       Don’t expect things to bounce back soon

Some watchers of China’s economy believe there is 5 years’ worth of oversupply in residential property .  The only way to address this overhang is through time and a significant slowdown in construction activity. It has been suggested that a dramatic cut of between 50% and 75% in construction activity levels is required.

What should investors do?

Investors who wish to retain exposure to the iron ore sector should focus on owning the lowest cost producers – for example FMG has forecast C1 costs of US$34/wmt and a breakeven cost of US$70/tonne.

Stay away from the marginal, high cost producers and definitely be wary of iron ore explorers as getting funding and turning a  deposit into reality will become increasingly difficult the lower the iron ore price goes.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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