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Warning: Iron ore to fall below US$40

BHP Billiton logo
Credit: Lucas Walters

Iron ore has enjoyed a strong few weeks, but don’t expect that to last.

Goldman Sachs is betting on a major decline in the commodity’s price over the next 18 months, and the impact could be brutal on the industry.

According to reports from The Australian Financial Review, the investment bank believes iron ore could slump another 30 per cent.

From today’s price of US$56.66 a tonne, according to the Metal Bulletin, that would imply a fall below the US$40 mark – a price not seen since at least 2009.

Indeed, the commodity bottomed out at only US$44.59 a tonne just over five weeks ago.

Of course, it’s managed to recover 27% in the time since, much to the relief of the nation’s miners.

At its recent lows, companies such as BC Iron Limited (ASX: BCI) and Mount Gibson Iron Limited (ASX: MGX) were under immense pressure and possibly operating at a loss.

Fortescue Metals Group Limited (ASX: FMG) was also in danger. Although it maintains lower operating costs than most of its rivals, it carries a bucket-load of debt making it a dangerous prospect.

Imagine what will happen if, as Goldman Sachs expects, iron ore heads below US$40!?

At that price, you can imagine Atlas Iron Limited (ASX: AGO) will be forced to close its doors once and for all.

The company recently begun trading again on the ASX following a four-month suspension as it scrambled to sell shares and restructure its business with one goal in mind: to stay alive.

Just as any eighth-grade economics student could tell you however, a rise in supply (from Australia and Brazil) combined with a drop in demand (from China) can only mean one thing:

Iron ore will continue to fall.

Right now, it’s really just a matter of when.

That’s bad news for the Australian government (sorry Joe Hockey). It’s bad news for the miners, and it’s terrible news for investors who have their money tied up in them.

Not even BHP Billiton Limited (ASX: BHP) or Rio Tinto Limited (ASX: RIO) will walk away unscathed if iron ore does fall to the levels predicted by Goldman Sachs.

Sure, they’ll likely still make a profit at that level, but their margins will be wafer thin, and their dividends could also come under enormous threat.

You can just imagine how investors would react should that happen…

Right now, the risks are simply too great to justify an investment in the sector. Thankfully, there are plenty of other great opportunities presenting themselves on the ASX instead!

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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