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Down more than 80%: Is now the time to buy Australia’s junior iron ore miners?

It’s been a terrible year for Australia’s iron ore miners, but some have been hit notably harder than others.

As can be seen in the chart below, companies such as Arrium Limited (ASX: ARI), BC Iron Limited (ASX: BCI) and Atlas Iron Limited (ASX: AGO) have all lost more than 80% of their value. Then you’ve got the larger miners, being BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) which have only lost 13% and 14%, respectively. Fortescue Metals Group Limited (ASX: FMG) is somewhere in between, its shares having deteriorated 49% over the last 11 months.

Iron Ore miners 2014

Source: Google Finance

So why have the smaller miners been hit so much harder than the industry’s bigger players?

Higher Costs

The speed at which the iron ore price has dropped this year has even taken the market experts by surprise. While most analysts had forecast it to drop below last year’s price of roughly US$135 a tonne, no one anticipated it would drop to just US$70 a tonne. And now, they’re suggesting it could drop into the US$50s at some point next year.

Of course, this could certainly impact the margins of the bigger miners, although they’ve been heavily ramping up production levels which will at least partially offset the damage. Fortescue has also been ramping up its production levels, but investors are justifiably concerned about its enormous debt level which will become increasingly difficult to repay as the commodity’s price drops.

However, the three miners maintain low breakeven costs, meaning they are equipped to cope with this lower price environment.

The smaller miners, on the other hand, are in a very dangerous position. Given their smaller production rates, they maintain higher costs and therefore run the risk of operating at a loss should the iron ore price fall any further. Indeed, numerous mines around the world have already been run into the ground and Australia’s miners are by no means immune.

Low Quality

The quality of the ore typically offered by the junior miners also needs to be considered. With companies like BHP and Rio Tinto producing high quality ore, Chinese buyers are showing less interest in lower quality products, which then forces companies such as BC Iron to offer discounts. That is, the juniors are not only being squeezed on the cost front, but on the revenue front as well.

What should investors do?

The shares of Australia’s miners received a welcomed boost on Monday following news that China would cut its interest rates. While this could result in a rebounding iron ore price – which would likely see the junior miners surge in price –counting on this would be a dangerous strategy for investors to undertake.

While global supplies of iron ore continue to skyrocket, demand growth is slowing considerably which, over the long-term, could see the commodity’s price sink much further. Investors wanting to play it safe should avoid the sector altogether and consider the slew of other attractive investment opportunities available to them instead.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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