Why iron ore could fall further

Record production volumes will do nothing to help tumbling prices in 2016.

Summary: Analysts see further falls in iron ore prices as a significant possibility - perhaps into the $20s a tonne range, if market conditions fail to improve. ANZ predicts prices in the range of $35 to $40 this quarter, while Citigroup sees it hovering around $35 for two years from later in 2016, as the global glut continues.

Key take out: The continuing high levels of production, despite China’s decreasing appetite for iron ore, could mean prices stay below $50 for some time.

Key beneficiaries: General investors. Category: Shares.

Has iron ore hit rock bottom? That’s unlikely, say many market watchers.

Despite nearly halving in value two years running, analysts forecast that the commodity’s rough patch will extend into 2016, as big miners churn out record volumes despite the diminishing appetite of dominant buyer China.

Iron ore fell as low as $37 a metric tonne in mid-December, the cheapest in a decade and down more than 80 per cent from its peak a few years earlier, making it one of the biggest losers among commodities. Although the price has edged higher since then, the market is unlikely to have reached its nadir, says Australia & New Zealand Banking Group analyst Daniel Hynes.

ANZ’s prediction is that prices will hover around $35 to $40 a tonne through this quarter, although Hynes admits “the probability of prices breaking below this range in the short term is rising daily.”

Some are calling an iron-ore price in the $20s if the current market dynamics don’t improve. “Anything’s possible at the moment,” says Hynes.

That would hurt, and mean that all gains from a China-led boom have pretty much been erased. The price for ore leaving Australia’s Port Hedland, now the world’s biggest iron-ore export hub, averaged $30 a tonne between 1980 and 2005, according to a BHP Billiton estimate published last year in 2015-dollar terms.

So, what would it take for prices to dive to the $20s? A further slide in oil futures and the currencies of big exporters could do the trick, says Citigroup. That would make mining the commodity more profitable for producers, and thus keep struggling pits open longer, exacerbating a market oversupply.

Like many other commodities, including oil, iron ore’s demise has been rooted in a global glut. Miners in places such as Australia and Brazil have been digging up rising volumes of the steel ingredient in a bet that China’s expanding economy will require more for skyscrapers, railways, and cars. Last week, Rio Tinto Group (ticker: RIO), one of the world’s biggest suppliers, said its annual shipments rose 11 per cent in 2015. Compared with three years earlier, shipments were up more than a third.

But China’s economy has waned along with its willingness to pay high prices for foreign ore. Last year, as rising numbers of vessels loaded with ore were departing Australian shores, China’s economic growth retreated to its slowest in a quarter of a century.

Citigroup foresees prices crumbling to $35 a tonne later this year and sticking around that level for the two years that follow. But it has also forecast a “bear case” in which the commodity goes to $28 instead.

“Everyone in the world is very aware of iron ore’s problems,” says Australia’s Macquarie Group. “However, we are not in the camp that sub-$40 a tonne iron ore is the new normal,” it added in a January 18 client note. Macquarie acknowledges iron ore is “one for the brave,” but the firm projects rising demand heading into midyear on a rebound in steel output, which has been flagging.

Iron-ore prices have already been dragged higher in recent weeks on the back of better Chinese steel prices, trading at $41.11 a tonne on the CME Globex last Friday, up from $40.79 a week earlier.

Still, oversupply remains an issue. “With the iron-ore majors intent on continuing to ramp up low-cost output, it looks as though iron-ore prices are set to stay below $50 for a considerable time,” says London broker Sucden Financial.

* This piece has been republished with permission from Barron's

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