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The outlook for iron ore and Australia’s miners

The iron ore market is being hit by a double whammy of falling demand, as well as rising supply. Iron ore is the primary ingredient in steel, and Chinese steel manufacturers having been over-producing for some time – that now appears to be falling.

That likely means even lower steel demand and production – at the same time as iron ore majors like Brazil’s Vale, Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP), Fortescue Metals Group Limited (ASX: FMG) and Gina Rinehart’s Hancock Prospecting are either ramping up production, or are about to bring new iron ore mines online – further increasing supply.

The odds are that the iron ore price is headed lower, possibly much lower than its current level of around US$83 a tonne. Already two small iron ore miners have fallen into administration – Termite Resources and Western Desert Resources Ltd (ASX: WDR) – and other higher cost producers may not be far behind.

Given their relatively higher production costs, investing in the likes of Mount Gibson Iron Limited (ASX: MGX), BC Iron Limited (ASX: BCI), Arrium Limited (ASX: ARI), Atlas Iron Limited (ASX: AGO) and other smaller iron ore miners is fraught with danger. No matter their huge dividend yields in some cases or massive cash balances in others.

If they aren’t loss making already, it probably won’t be long before they are, if the iron ore price keeps sinking.

The majors like Rio, Vale and BHP aren’t likely to go broke, but the falling commodity price will hammer their earnings (and consequently their share prices). Fortescue, with its huge US$7.2 billion in net debt, could be at risk of being unable to meet its interest payments if the price falls much further.

The one saviour that has normally protected commodity exporters from falling prices, a falling Australian dollar, hasn’t materialised yet. Whether it will come to the rescue is hard to know, but it may be too late to save some Aussie miners.

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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

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