Iron ore has staged a 12% turnaround since hitting a new low of US$44.59 just under a week ago, but the relief isn't expected to last for long with Citi expecting a fall below US$40 a tonne by the end of the year.
Iron ore is a commodity that is mostly used for producing steel. Demand for the resource skyrocketed during China's boom years during which the Asian heavyweight experienced rapid growth, but that demand growth is now quickly deteriorating as its economic expansion slows.
Meanwhile on the supply side, the world's largest producers are ramping up their production levels in an effort to reduce costs per tonne produced, pumping a tidal wave of extra supply into the market at a time where it simply is not needed.
The Brazil-based Vale recently said it would cut 25 million tonnes of unprofitable iron ore, although that would be replaced by cheaper production to ensure long-term volume targets (340 million tonnes per annum) are still achieved.
With all this combined it's likely that iron ore is heading down.
Although the commodity's price has fluctuated heavily so far this year, Citi believes it will trade in the US$30s a tonne range in the second-half of 2015, according to the Fairfax press. Indeed, a similar belief is also shared by Capital Economics and Goldman Sachs.
Such a scenario would be disastrous for Australia's high-cost producers, many of which are likely struggling to turn a profit even at today's level of US$50 a tonne. That could include miners such as BC Iron Limited (ASX: BCI), Mount Gibson Iron Limited (ASX: MGX) and even Fortescue Metals Group Limited (ASX: FMG), which carries a mountain of long-term debt.
At today's price, Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are still making a profit on whatever they produce, albeit on thinner margins than earlier in the year. A fall into the US$30s could severely impact their profits and cash flows, and could certainly impact their ability to grow or even maintain their dividend payments to shareholders.
Successful investing is all about stacking the odds in your favour, and right now that is not achievable in the iron ore sector. Investors would be wise to ignore the industry's lure and focus on some of the market's other attractive alternatives.
