Shares of Fortescue Metals Group Limited (ASX: FMG) have copped a flogging today as investors grow increasingly nervous about a potentially large pullback in the price of iron ore.
Iron ore hit a 10-year low of US$46.70 a tonne earlier this year but has since recovered substantially, temporarily climbing above US$65 a tonne more recently. While iron ore bulls would like to think that the price can be sustained around that level, realists are recognising that such a situation is unlikely.
The fact is, China's growth is slowing down at a rapid clip. At the same time, the world's largest miners such as BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Vale are ramping up their production rates, flooding the market with supplies it simply does not need.
Goldman Sachs recently said it expects iron ore to trade below US$50 a tonne before the end of the year – implying a nearly 20% decline compared to today's price – while UBS, ANZ and the government have also weighed in with their bearish forecasts.
Although the iron ore price only fell 0.5% overnight, investors are likely assessing the risks associated with the stock in the event that prices do fall further.
Fortescue Metals Group maintains far lower operating costs than some of its smaller rivals, yet much higher than those enjoyed by BHP, Rio Tinto or Vale. Furthermore, Fortescue carries an enormous pile of debt which could threaten to derail the company if the iron ore price does fall below its breakeven price.
While some investors might find it to be an appealing prospect at $2.01 per share (down 5.2% for the day), 'Foolish' investors would be wise to recognise the risks associated with the stock and ignore its lure altogether.
