It's no secret that the mining sector has acted as a huge weight on the Australian share market in recent years. That has especially been the case over the last 13 months, in which time the iron ore price has crashed more than 50% to just over US$61 a tonne.
The simple truth is that Chinese growth is slowing at a rapid clip, having recently recorded its slowest annual growth rate in 24 years. Joe Magyer, manager of our real-money portfolio service, Motley Fool Pro, saw this first-hand recently on his research trip to China, reporting that he had counted 53 cranes in 2 minutes whilst travelling on the bullet train between Tianjin and Shanghai – every single one of which was sitting idle.
While the nation is responsible for demand for a massive two-thirds of the world's seaborn ore, its slowing demand has impacted the price of the commodity itself.
Then of course, the crisis has been exacerbated by the world's largest miners which have rapidly expanded their production numbers, flooding the market with fresh supplies. BHP Billiton Limited (ASX: BHP), for instance, is on target to produce 290 million tonnes annually by the 2017 financial year, while Rio Tinto Limited (ASX: RIO) is set to produce 330 million tonnes this financial year.
Their growing output poses as a huge problem for the mining industry as a whole. As Joe noted, UBS forecasts that iron ore's oversupply could hit more than 200 million tonnes by 2018, up from roughly 35 million tonnes today.
Should this scenario play out, the commodity's price will only fall further. While higher cost producers such as Arrium Ltd (ASX: ARI), or those with enormous debt loads, including Fortescue Metals Group Limited (ASX: FMG), could be forced from the market, the lower prices would also put pressure on BHP Billiton's and Rio Tinto's cash flows which could see their shares fall from current levels.
As if that's not dangerous enough, BHP Billiton is facing another enormous problem. While iron ore generates the largest portion of BHP Billiton's earnings, it also derives a huge chunk from its oil division which is also facing a massive oversupply problem. The resource's price has more than halved over the last seven months with the International Energy Agency (IEA) predicting that there could be a two million barrel per day supply imbalance in 2015. If prices continue to fall, BHP Billiton's cash flows will come under even more severe pressure.
While BHP Billiton and Rio Tinto might look appealing when commodity prices are riding high, they're by no means a pretty sight when things are going pear-shaped. With further falls tipped for both commodities over the coming 12 months, investors would be wise to steer clear.
