Investors might want to think again before loading up on shares from the iron ore sector.
The commodity's price held up surprisingly well through the market's recent jitters, prompting some analysts to suggest the commodities rout had finally found a floor. According to The Age however, Citigroup's China commodities strategist believes the recent pricing activity for iron ore is mostly attributed to a temporary match between demand and supply, and does not reflect a longer-term trend.
In fact, the same strategist believes iron ore will fetch as little as US$40 a tonne early next year. That's down more than 24% from its overnight price of US$52.79 a tonne, according to the Metal Bulletin, which is its lowest price in nearly three months. It's also well below the commodity's seven-year low around the US$44 mark in July this year.
Indeed, an investment in the iron ore sector is a bet on the future iron ore price. Miners within the sector rely heavily on a higher price to maintain reasonable earnings and many could be forced to shelve projects if prices do fall that low.
An investment in the sector is also a bet on China's growth potential. China, which buys the vast majority of the world's seaborne iron ore, is now growing at its slowest rate since the Global Financial Crisis and tipped to slow down even further in the coming years. In addition, it is transitioning away from infrastructure growth towards a more services-based economy, which will result in less demand for key commodities.
Of course, because iron ore is priced in US dollars, a weaker Australian currency will help to support Australia's miners to an extent. But the headwinds facing the industry as a whole are by no means encouraging and indicate that long-term investors would be wise to avoid the sector altogether.
To my mind, that even includes the bigger players, being BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO). Although both would be somewhat protected, thanks mostly to their low cost operations, even they could suffer a heavy loss in earnings which could certainly be reflected further in their share prices.
