Iron ore producers are continuing to hope for the best. But, despite wishful thinking, this commodity is still taking a plunge.
A couple months ago, I warned Wall Street Daily readers to stay away from iron ore and the companies that produce it.
Unfortunately, my prediction has proved to be spot on.
Iron ore has continued to tumble and is now trading at its lowest price in about five years. It’s down 38% this year alone!
On September 3, the Australian benchmark iron ore price fell below $85 per metric ton for the first time since September 2009.
Things are certainly looking bleak for this sturdy commodity.
But now, new data about supply and demand is providing investors with a more complete picture of just how far this sector will fall.
Chinese Demand Slipping
The Chinese have a huge influence over the commodities sector, and iron ore is no exception.
Normally, China imports two-thirds of the world’s seaborne iron ore. But things are hardly normal right now.
China’s real estate sector is slowing down, meaning there’s less demand for building materials.
The Wall Street Journal recently reported that a key rebar (a reinforcement bar made with iron ore) contract price is trading at a seven-year low.
With such a low rate of new building projects, the writing is on the wall for all to see.
Most industry analysts expect China’s iron ore consumption to be relatively flat this year.
This is not good. Especially when you consider that China’s iron ore consumption growth rate was in the double digits not too long ago.
Warning: Supply Overload!
The real downfall of the iron ore market, though, is the supply surplus. Major iron ore producers are continuing to harvest the commodity despite the drop in demand.
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Through the mid-year, BHP’s output was up 20%, while RIO’s was up 10%. Plus, the No. 4 iron ore producer, Fortescue Metals Group ADR (FSUGY) in Australia, increased its iron ore output by 29% in the first half of 2014.
The industry produced about 1.1 billion metric tons (bmt) for export in 2014, and that figure is expected to reach 1.4 bmt by the end of 2015.
Overall, we’re seeing the largest increase in iron ore production ever.
The suppliers are insisting that the 125 million metric tons or so of high-cost iron ore production that are being slashed this year (mainly in China) will offset their increased output.
However, investors have little faith that things will even out.
Vale’s stock recently capped its longest losing streak in eight months and is down about 25% from its 52-week peak.
And Down It Goes…
For the giants of the industry, the growing imbalance between supply and demand will definitely have an effect on their bottom lines.
In August alone, the price of iron ore tumbled by $7.60 a ton. The Financial Times says that translates to a nearly $1-billion cut in profits for both BHP and RIO.
Yet, management at these firms stubbornly continue to believe that Chinese demand will come roaring back to levels seen years ago.
That’s unlikely. What’s more likely is that a huge surplus in the market will develop.
A good estimate comes from Carole Ferguson of London-based fund manager SP Angel. She forecasts that if Chinese demand continues at its current pace, the global iron ore market will see a 200-million ton surplus in 2015.
Translation: We’ll see $70 to $80 per ton of iron ore before we see $100 per ton again. Avoid the stocks.
And “the chase” continues,