5 reasons not to overreact to the falls in the iron ore spot price

Iron ore prices have fallen sharply, but now is not the time to panic.

a woman

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Iron ore miners provide a significant contribution to the Australian economy. With companies such as BHP Billiton Limited (ASX:BHP), Rio Tinto Limited (ASX:RIO) and Fortescue Metals Group Limited (ASX:FMG) playing a material role in many investors' portfolios. Even if you are not an active investor, you are still likely to be affected by these stocks through your superannuation funds.

It is therefore not surprising that the recent drop in the iron ore spot price to below $USD100 per tonne has caused much panic within the market. However for the following five reasons I believe the panic has been over done and longer term prospects for these miners remain strong.

1)     Profit margins remain healthy above $USD80 per tonne

Australian iron ore producers are some of the most cost effective producers in the world. With cost of production (including shipping) well below the current  spot price these iron ore miners remain profitable at these levels. Many industrial and retail based companies could only dream of the margins available to the major miners.

2)     China is still growing

With such panic you could be mistaken for thinking China is no longer growing. However not only is the economy growing, the IMF has forecast growth of 7.7% and 7.3% for 2014 and 2015 respectively.

3)     Healthy balance sheets

Take Atlas Iron Limited (ASX:AGO) for example, which has seen its share price fall a dramatic 35% this year. With a market capitalisation of only $677 million, low debt and cash at bank of $372 million, investors should think twice before hitting the panic button.

4)     Increase in production capacity

Many fear that the investment made by miners in expanding production capacities will result in further oversupply. This is true to an extent, but will be largely offset by the lower cost of production.

5)     Mr Market has already factored in much of the downside risk

The sharemarket generally anticipates events before they take place. Therefore the current slump in the iron ore spot price has already been factored into the share price. History has taught us that the best time to buy a stock is generally at the bottom of a cycle when all the bad news is on the table.

Further upside could exist with any consolidation that could take place within the sector. Take Atlas Iron for example, with a price to book ratio of only 0.42 and substantial cash at bank it could be a takeover target.

Motley Fool contributor Tim Roberts owns shares in Atlas Iron (ASX:AGO)

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