INSIDE INVESTOR: What the fall in iron ore prices means for the ASX

Foreign demand for Australian dollars and bonds has offset the recent volatility in iron ore prices. How long will it last?

It is common knowledge that iron ore prices have been highly volatile of late, especially to the downside. From $US180/t a year ago to recent lows of $US86/t, it’s been a sharp and viscous plunge, especially for those companies and investors betting big on iron ore strength and the continuation of the China growth story.

The precipitous fall in prices has been detrimental to iron ore stocks, especially the pure play miners that only deal in the iron ore game. Australia’s most high profile and leveraged bet on iron ore prices is Fortescue Metals Group, and it has been in the news for all the wrong reasons recently. They are highly geared with ambitious expansion plans, and subsequently have been sold down very hard. In fact, the likes of Atlas Iron, Fortescue Metals Group, Gindalbie Metals and Mountain Gibson Iron Ore are down well over 50 per cent over the last 18 months.

Looking at the economy, the effect of iron ore price falls is definitely visible, although not as clear as in the equity market. So far the falling iron ore price has seen a number of big capital expenditure projects delayed or terminated. These decisions send ripple effects down the chain to mining services firms, engineering firms and obviously to the workers that were going to be employed in these projects, which directly impacts at the household level.

The decline in iron prices, as well as other commodities,means Australia’s terms of trade (price of exportable goods/price of importable goods) is now falling, which should be negative for the Australian dollar. However, due to overseas demand for Australian dollars and bonds, because of the relative safe haven view, these potentially negative impacts are being offset by the increased offshore buying of Australian dollars.

Without this demand, we would almost certainly be seeing some downside impact on the Australian dollar. As conditions overseas slowly improve, the demand for Australian ‘safe haven’ assets should in theory start to diminish, which in turn should see the Australian dollar starting to come under pressure.

How long it takes is anyone’s guess.