Investors are cutting their exposure to iron ore as the industry faces a flood of new supply that has pushed prices for the steelmaking ingredient close to two-year lows.
Billions of dollars are being spent by resources companies on new iron ore mines in countries from Australia to Brazil, aiming to meet Asia's appetite for steel used in everything from apartment buildings to cars. But many investors are concerned that demand isn't strong enough to soak up that extra supply and the industry could face a prolonged slump that could force shut downs of higher-cost mines as well as layoffs.
"In previous years we have seen a sharp sell-off followed by a sharp rebound," Neil Gregson, a fund manager at JP Morgan Asset Management said. "This time we don't think there will be that sharp rebound."
The benchmark price of ore with 62 per cent iron content imported through China's Tianjin port is down by about one-third this year, as rising supply from Australian mines gives steelmakers the upper hand in negotiations. Iron ore was trading at $US93.70 a tonne overnight, after slipping as low as $US89 a tonne last week to its weakest level since September 2012.
In recent months, Mr Gregson became a seller of Australian iron ore producers including Rio Tinto and Fortescue Metals Group, contributing to falls of 14 per cent and 26 per cent in their respective share prices since the start of this year. He expects iron ore prices to move in a $US10-band either side of current levels.
Mr Gregson isn't alone in taking a more bearish view. In recent weeks, brokers including Deutsche Bank and Commonwealth Bank of Australia have slashed their forecasts for iron ore prices. Morgan Stanley lowered its price estimates by 21 per cent in each of the next two years, to $US90 a tonne in 2015 and $US87 a tonne in 2016, saying it had underestimated the speed at which new mines were starting up.
About 1.3 billion tonnes of iron ore is traded by sea each year, with more than half of these shipments heading to China. Over the past decade, supply has largely kept pace with demand, aided by India curbing output and exports on environmental concerns.
However, UBS predicts the seaborne market will be awash with almost 74 million tonnes of surplus iron ore this year. By 2016, the seaborne market could be oversupplied by 267 million tonnes -- or as much as Rio Tinto, the world's No. 2 iron-ore exporter, produced last year.
According to Tom Price, a Sydney-based analyst at UBS, the market is feeling the ill-effects of an "epic, price-suppressing, Aussie-led supply surge."
Rio is aiming to increase its Australian iron ore output by a further 20 per cent to 350 million tonnes within two years, while Fortescue completed a $10 billion expansion of its mines in late March. These investments are already feeding through into sharply higher exports, with ports in the country's Pilbara region loading vessels at record rates.
"Over the past decade, virtually all new iron ore supply was for seaborne export to China. That trend cannot continue with the headwinds the Chinese economy is now facing," said Adrian Martuccio, senior portfolio manager at Bell Asset Management, which oversees around $US5bn.
These headwinds include a probe into metal-backed financing as banks withhold credit and customs officials tighten checks.
Many investors also expect the pace of steel production in China to slow, as Beijing reins in capacity in the bloated sector.
"We saw steel demand flattening out or growing at a slower rate but, more importantly, we saw the supply situation was going to aggravate that demand slowdown," said Robert Hook, a Melbourne-based fund manager at SG Hiscock & Co.
Still, some brokers, including New York-based Jefferies, continue to recommend investors buy shares of major miners like BHP Billiton and Rio Tinto due to increases in their dividends.
Mining companies are also moving to reduce costs and protect profits from a falling iron ore price. BHP recently cut 100 jobs at the Perth headquarters of its iron ore division, with a further 170 layoffs at the company's Mt Whaleback mine in the Pilbara.
Rio Tinto is betting that its Pilbara mines will continue to be big moneymakers even at a lower iron-ore price, with high-cost mines in China most at risk from a sustained downturn.
"I think what they are saying is: 'We have good quality ore and we are going to produce it, and if the lower quality guys fall by the wayside then tough,'" Mr Hook said.
Source: Business Inspector
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