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Broker sounds warning bell on market mayhem with coming iron ore price crash

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It’s a controversial call that’s bound to shock but RBC Capital Markets is telling investors to brace for mayhem as it believes the price of iron ore will crash within the next few months, if not sooner.

This is an out-of-consensus-call if I ever saw one as analysts have been upgrading their price assumptions on commodities due to the strength of the global economy.

RBC Capital is bucking the trend and is predicting that the price of the steel making ingredient will collapse more than 20% in the current half to average US$49 a tonne.

A drop below the psychologically important US$50 per tonne mark is likely to cause “Pandemonium”, as RBC Capital describes it, and I couldn’t agree more.

The broker had initially forecast a price of US$65 a tonne for the steel making ingredient for the second half of calendar 2018 and the price of the commodity is hovering around US$64 a tonne at the moment.

Any decline of 20% or more is a bear market and will prompt investors to dump shares in stocks like BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).

What is driving RBC Capital’s bearish near-term outlook is the Chinese economy.

“We argue that an increasingly difficult set of circumstances facing policymakers is likely to result in a material slowdown in the second half of the year,” said the broker.

“The key difference in our heretofore bullish view on China is what is now the exact opposite of 2016: the rising rate environment in the US, and related CNY weakness hampers the ability for policymakers to respond to a slowdown.”

RBC Capital believes that Chinese infrastructure spending will decline year-on-year at a time when the property construction market is cooling. These sectors account for nearly 60% of steel consumption in the world’s second largest economy.

This in turn will trigger a rapid drop in the price of iron ore, although the broker thinks this weakness will be temporary as the price of the commodity will rebound to US$63 a tonne in 2019.

But before you breathe a sigh of relief, the volatility will be damaging to the share price performance of our iron ore producers, particularly for Rio Tinto with RBC Capital downgrading the stock to “underperform” from a neutral-equivalent recommendation.

“RIO remains significantly more exposed to iron ore than peer BHP given the reduction in volume contribution from coal, and a lack of exposure to oil,” explained RBC Capital.

“As such, RIO’s fortunes will also remain linked to not only the rise and fall of the iron ore benchmark, but also sentiment.”

Perhaps the more troubling question is whether sentiment towards the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index will also be dragged lower given that iron ore is our country’s biggest export and any drop, short or otherwise, will cause investors to question the strength of the wider Australian economy.

But it isn’t all bad news. The threat of a global trade war is receding after the US and European Union struck a conciliatory tone overnight and the Chinese government is embarking on a fresh round of stimulus to support local industries.

However, those who are nervous about the potential bout of volatility might want to read the latest report from the experts at the Motley Fool.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. 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 Scott Phillips.

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