Here’s why the iron ore price could be set to plunge

Credit: iStock

It was only a matter of time before the iron ore price started to lose some of its heat again.

The commodity hit a low of around US$38 a tonne late last year and many experts in the field expected those declines to continue. But instead, in a move that virtually no one could claim to have foreseen, the iron ore price surged to a high of around US$64 a tonne. That included an incredible 18.6% gain in a single day earlier in the month – its biggest one-day gain in history.

While the recent rally was enough to spark excitement in the resources sector – creating plenty of demand for shares of companies such as BHP Billiton Limited (ASX: BHP) and Fortescue Metals Group Limited (ASX: FMG) – it seems the market is once again coming to terms with reality.

Since hitting those highs a little over a week ago, iron ore has trended mostly lower. It fell 2.7% on Monday night and then another 4.8% on Tuesday to trade at US$52.88 a tonne, according to data from The Metal Bulletin. And there are reasons to believe it will continue to decline in the foreseeable future.

To begin with, there are the obvious reasons – the same ones that have caused the iron ore price to plunge from its 2011 highs around US$185 a tonne to today’s levels. The world’s biggest producers are simply supplying too much ore at a time where demand growth is slowing. There is an oversupply in the market, and that situation could continue to worsen as a result of China’s inevitable economic slowdown.

The recent rebound has certainly given investors hope, but it’s difficult to see the commodity’s current price levels being maintained, let alone rising any further.

Another factor that could well be behind the recent rally is a temporary ramp-up in production in the major steel-producing city of Tangshan. The city will host an international horticultural exposition from late April through to October this year which, according to Reuters, could lead to an enforced shut-down of production during that period to limit the impact of pollution and smog in the atmosphere.

Should that happen, production could plummet and take the iron ore price down with it. I wouldn’t want to be too heavily exposed to the iron ore sector if it does come to that.

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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.

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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