Iron ore sinks 2.6% and is headed under US$40

The spot iron ore price fell 2.6% to US$41.13 a tonne overnight and all indications are that the trend will continue.

That’s obviously bad news, especially for Australia’s junior iron ore miners Atlas Iron Limited (ASX: AGO), BC Iron Limited (ASX: BCI), Mount Gibson Iron Limited (ASX: BCI) and Arrium Limited (ASX: ARI) which have much higher production costs than large miners.

Atlas Iron, in particular, is most at risk of ending up in administration. The Australian Financial Review reports that Atlas is at risk of breaching its debt covenants and is in talks with its bankers and advisers about potential options.

Atlas has US$270 million worth of debt on its books due in December 2017, and was forced to take drastic action in April this year after iron ore prices plunged. The company entered into profit sharing agreements with its contractors and they took a stake in the company in return for lowering rates, designed to cut Atlas’s production costs.

Atlas and other miners have already received royalty relief from the West Australian government, but that is a short-term solution and so far hasn’t solved Atlas’s problems.

Australia’s big three miners Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP) and Fortescue Metals Group Limited (ASX: FMG) have production costs of under US$20 a tonne, as does Brazil’s Vale, but will still feel the hit to revenues and earnings. As share prices tend to follow earnings, you could expect share prices to fall from here.

Why is iron ore falling?

Two main reasons:

  1. Massive global oversupply as this article shows.
  2. Weakening demand from China, which is being driven by a lower steel demand amid a glut of steel production, and many Chinese and Korean steel producers operating at a loss.

The situation is unlikely to change anytime soon, with even more iron ore supply coming onto the market, while steel production is forecast to fall even further. Essentially there’s virtually nothing that can stop the iron ore price from continuing to fall – one reason why I expect prices in the US$20 to US$30 per tonne range.

Look out below.

Foolish takeaway

If you are invested in the iron ore miners, be prepared for an extended period of lower earnings and share price falls. If you own shares in the junior miners, just be aware that there’s an extremely high risk of you losing all your capital.

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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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