It’s been a great year so far for commodities investors. The Dow Jones-UBS Index of 21 commodities is up 7.1%, beating both the S&P 500 Index and 10-year Treasury bonds.
But there’s one commodity in particular that hasn’t been as prosperous: iron ore.
This crucial steel ingredient has crashed 30% in 2014 as a wave of new supplies has overwhelmed demand.
Surplus Continues to Grow
Across the board, the metrics are looking grim.
The benchmark price for iron ore with 62% iron content has fallen below $90 per metric ton (mt) for the first time since 2012.
Meanwhile, the situation is even worse for producers of lower-grade iron ore. The spread between the two grades has widened from $10 per ton last year to around $18 per ton.
Yet it seems the oversupply won’t be ending anytime soon. Analysts predict a seaborne iron ore surplus of 75 to 80 million mt this year, and if the industry continues on its present course, the market may see a whopping surplus of 267 million mt by 2016.
To put it in perspective, that’s equivalent to the entire 2013 iron ore production of mining giant Rio Tinto PLC (RIO)!
The real problem is that iron ore companies are stubbornly increasing their output, expecting Chinese demand to save them. RIO, for instance, is increasing its output from its Australian mines by another 20% (350 million mt) within two years.
However, continued growth in Chinese steelmaking is hardly a given, and I can just hear the investors at RIO shouting to management, “Stop the madness!”
Smaller, Lower-Grade Mines to Close Up Shop
Of course, diversified miners like BHP Billiton (BHP) and RIO, which also produce higher-grade ore, won’t feel the brunt of the iron market’s carnage.
Instead, lower-grade ore producers, such as Australia’s Fortescue Metals Group (FSUGY), will feel the most pain as Chinese demand shifts toward higher-grade ores. Amazingly, Fortescue is down by more than 25% so far this year, yet it went ahead with a $9.2-billion mine expansion project in March.
In China, the market is starting to respond to the inventory surplus. On June 30, the China Metallurgical Mining Enterprise Association reported that 25% of domestic iron ore mines have been idled already.
Yet that’s still not enough to bring the iron ore market into balance in China. In late June, record inventories of iron ore (to the tune of 113.65 million mt) were being held at Chinese ports.
Bottom line: The seaborne iron ore market may be in a surplus for many years to come, leaving iron ore on the downside even as commodities enjoy a strong first half in 2014.
Source: Wall Street Daily
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