Are the iron ore miners set to gap down again?

A recent rally was the catalyst behind huge gains for Rio Tinto Limited (ASX:RIO), Fortescue Metals Group Limited (ASX:FMG) and BHP Billiton Limited (ASX:BHP).

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It seems the iron ore rally may have finally reached a turning point with the commodity once again slipping below the US$50 a tonne mark.

The price of iron ore surprised economists and investors alike when it rebounded strongly from a six-year low around US$38 a tonne in December 2015 to almost US$52 a tonne last week.

The move sparked a rally in some of Australia’s biggest miners, including Rio Tinto Limited (ASX: RIO), Fortescue Metals Group Limited (ASX: FMG) and BHP Billiton Limited (ASX: BHP) – the latter also benefited from a stronger oil price. Indeed, investors wanted to believe that the commodity had finally found a floor, and that they could buy shares in the miners right at the turning point in time for a recovery.

Unfortunately, that doesn’t appear to be the case. The iron ore price has now fallen over two consecutive sessions, including a 3.7% drop on Thursday night and another 2.9% on Friday. One tonne of the metal is now fetching US$48.29, according to data from The Metal Bulletin, which represents a total loss of 6.5% over the last two sessions.

Of course, it’s still sitting nearly US$10 a tonne higher than it was in December, but there are reasons to believe it will continue to decline back to those levels. For starters, global production still far outweighs demand, and the imbalance could get worse as China transitions its economy away from being driven by industrial growth and towards growth driven by consumption and services.

While Rio Tinto, BHP Billiton and even Fortescue have the capacity to weather the storm at the current price level, their earnings could fall even further if the iron ore price does continue to decline.

The outlook is even worse for some of the country’s smaller miners with higher operating costs, some of which may be forced to close their mines for good. Arrium Limited (ASX: ARI) is certainly at risk at the moment after it recently warned investors it was uncertain “whether the group will continue as a going concern“.

While I would avoid the junior miners in particular based on the high level of risk, I’d also suggest investors would be wise to steer clear of the bigger miners as well until the outlook becomes clearer, or until their shares become too cheap to refuse. I don’t think they’re at that point just yet.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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