How Low Can Iron Ore Go?
During the course of 2015, the price of iron ore slipped approximately 31%. It bottomed out on 8 July at $44.59, but has since regained ground to trade over $50 per tonne. In looking to apportion blame for the commodity price rout, the usual suspects can be pointed to – China, Eurozone weakness, recessionary concerns in Japan, and a rampant US dollar. Combined, these factors have the effect of reducing the demand for iron ore, but not the supply of it. It's important to understand precisely why the supply of iron ore continues unabated, despite the fact that the demand for the commodity is substantially weaker. In much the same fashion as crude oil producers are prioritizing market share above profitability, iron ore producers are following suit.
Shoddy Performance of Mining Companies
The evidence corroborating a slowdown in China is pervasive. For starters, September import figures year-on-year for China declined by 20.4%, while October figures declined by 18.8%. Since a substantial component of Chinese imports is made up of mining and energy commodities, iron ore exports to China have taken a huge hit. The year-to-date performance figures for the leading mining companies are none too flattering. For example, the following declines have been reported of late:
· Fortescue Metals Group Ltd (AX:FMG) has a year-to-date return of -16.79%
· Rio Tinto (L:RIO) plc has a year-to-date return of -25.20%
· BHP Billiton (L:BLT) Ltd has a year-to-date return of -26.29%
· VALE SA (N:VALE) has a year-to-date return of -51.47%
The general trend for mining companies across the board is the same: revenues and profitability are way down, and future prospects are bleak for the iron ore industry. We are seeing an interesting change taking place in the sense that smaller mining companies with higher costs of operations are being forced to close up shop, while the bigger companies are able to sustain their operations owing to economies of scale and significant clout in the industry.
What are Industry Analysts Saying?
Cliffs Natural Resources Inc (N:CLF) – one of the biggest iron ore producers in the US – believes that mining companies who are happy about a price below $50 per tonne for iron ore are being unreasonable. The problem it seems is that revenues are declining faster than costs are for mining companies. Weakness is pervasive across companies in the mining sector, and this is evident in the negative figures we are seeing with the aforementioned mining companies. Losses are likely to continue moving forward, and China weakness is a big factor in determining the overall demand for iron ore and related commodities. It is emerging market countries which are suffering as a result of weak demand from China. The multinational conglomerates that operate in the Democratic Republic of Congo, Zambia, South Africa, Nigeria and other EM countries are posting some of their weakest performances on record. One only has to look at companies like Anglo American (L:AAL) and Glencore (L:GLEN) PLC as cases in point.
But there is hope for an uptick in the performance of mining stocks. China consumes 800,000,000 tonnes of steel every single year. This is substantial, and iron ore is an essential component of steel production. It's not so much that demand in China is causing the price to fluctuate; it is the policy decisions that the Chinese government is taking that are causing all of this uncertainty at this time. China still has as its goal the One Belt One Road initiative. This ambitious undertaking is geared towards connecting Asian countries with the Middle East and Europe. In so doing, China will be able to supply all of these countries that border it. This will bring about a resurgence in demand, but the Chinese economy is still in the process of pivoting away from an export-driven market to a consumer-centric market where the focus is on infrastructure growth and development and services delivery. For now, iron ore prices are going to remain at sub-optimal levels and profitability will be adversely affected.
