Here’s why iron ore prices aren’t crashing

Credit: iStock

Iron ore prices dropped 1.8% overnight to US$59.38 a tonne, but have remained above US$50 a tonne since March 1, despite numerous reported headwinds.

As we wrote a month ago, the commodity price has so far defied expectations, at the time rising 18% (and we noted that it appeared to have established a holding pattern above US$50 a tonne).

iron ore price 2016

Source: Quandl


Most factors attributed to the rising iron ore price were expected to be temporary, but there is one factor that may very well be holding the iron ore price up.

According to Metal Bulletin analysts, “China’s domestic iron ore production continued to fall during the first two months of the year, with volumes down 60% year-on-year amid weak prices in a low season.

Reports also suggest that loads of higher-cost Chinese iron ore mines stopped producing the commodity in the wake of the low iron ore prices in December and January, when it regularly traded around US$40 a tonne.

Metal Bulletin also quoted Chen Guanyin, an analyst at Minerals & Jingyi Futures as saying at a Beijing iron ore conference in March, “Only 30% of domestic mines were running in January, squeezed out of the market by low-priced imports. In Qian’an, a major iron ore hub in North China’s Hebei province, only 3 miners were operating, compared with more than 50 previously.

According to the US Geological Survey, Chinese iron ore peaked in 2014, and fell at the fastest rate in 2015 since 1998. Around 130 million tonnes of production was estimated to have dropped out of China in 2015.

Chinese iron ore imports are also soaring, thanks to the lower-cost, higher quality Australian and Brazilian product. Many of China’s steel mills are also located along the coast, making imported ore much more accessible than domestic mines located hundreds of kilometres away.

Those same steelmakers are also looking to substantially lower their costs in the face of subdued steel prices, and one way to do that is to replace lower-quality ore with the higher quality ore from Australia and Brazil.

The major miners, Vale, Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are profitable at current prices, and the world’s fourth-largest producer Fortescue Metals Group Limited (ASX: FMG) has joined the party with C1 cash costs of below US$15 a tonne in the last quarter.

Gina Rinehart’s Hancock Prospecting is probably not too far away once it ramps up to full production at Roy Hill too.

The strong rise in the iron ore price this year has also helped the junior miners too. BC Iron Limited (ASX: BCI) has seen its share price rocket up 73%, while Mineral Resources Limited’s (ASX: MIN) share price is up more than 70% as well.

There are still storm clouds on the horizon though, with Rio’s CEO Sam Walsh telling reporters in London that prices may fall in the second half of the year, with global output set to increase and offset improving demand from China. Research firm, Liberum Capital, has echoed others’ forecasts with its estimate that prices will fall below US$40 a tonne in the second half, saying demand had been “front-end loaded and will taper off.

Foolish takeaway

Forecasting where commodities prices will be or might go is an almost impossible job to get right consistently. All the miners can really do is keep pushing out production, cutting costs where possible and hope prices don’t crash.

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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

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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