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Iron ore sinks to 10-year low and is headed lower

The spot price for iron ore tumbled overnight, falling 3.4% to US$42.97 per tonne, and Singapore futures are pointing to more falls.

It was the lowest level on record since spot pricing was introduced in mid-2009.

Iron ore futures fell below US$40 per tonne for the first time since December 2007, as concern over steel production and steel prices continues. Chinese iron ore futures also fell to the lowest closing level on record.

Metal Bulletin analysts wrote yesterday, “Billet prices in Tangshan fell to a new low at the weekend on news of more production cuts from [steel] mills. Northern China’s Jin’an Steel halted production at the end of last week amid mounting losses.

Many Chinese steel producers are operating at a loss due to a global steel glut and low prices. The problem is that Chinese banks are also cracking down on lending to steel producers. China’s second-largest steel producer Shanghai Baosteel Group stated in October that steel production may need to fall 20% in order to account for the massive oversupply.

It’s a similar situation that has played out before, with Europe, the United States and Japan all seeing their steel industry going through painful restructures.

A reduction in steel production also flies in the face of forecasts from Australia’s two largest iron ore miners, Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP). Both have been forecasting continued growth in steel production and demand for iron ore.

An iron ore price below US$40 a tonne will do major damage to their revenues and profits, but Rio and BHP should still be able to turn a profit, given their world-leading low production costs. Fortescue Metals Group Limited (ASX: FMG) should also be ok, given the ‘third-force’ in Australian iron ore has substantially lowered its production costs and also improved the quality of its ore.

Fortescue was receiving a heavily discounted iron ore price but constructed several beneficiation plants to blend high grade and low-grade ores to match the quality demanded by its customers. Strip ratios (the ratio of waste to ore) have dropped dramatically, allowing Fortescue’s cash costs to fall by more than 40% over the past two years. The miner is now operating at similar costs as BHP and Rio and could even surpass them.

But there will likely be some casualties, particularly among the junior miners, who don’t have the same scale as the majors, and, therefore, higher costs. BC Iron Limited (ASX: BCI), Arrium Limited (ASX: ARI), Mount Gibson Iron Limited (ASX: MGX), Gindalbie Metals Ltd (ASX: GBG) and Atlas Iron Limited (ASX: AGO) could all post large losses this financial year, and a worst case scenario could see one or more of them shut up shop.

Foolish takeaway

Analysts have been too bullish in their forecasts for iron ore, and I expect many to start taking a red pen to their commodity and resource company forecasts. It wouldn’t be difficult to envisage iron ore prices of US$30-something a tonne in the near future. Australia’s ASX-listed miners look set for a bad day on the markets today.

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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

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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