Despite a large decline earlier this year and unfavourable macroeconomic conditions, the value of iron ore has proved to be quiet resilient in recent times – not rising above US$60/tonne and rarely dropping below US$50/tonne over the past six months.
However, that could be set to change after the latest quarterly reports from Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP).
Rio reported a 12% increase in production compared to the same time last year and BHP followed suit with 7% lift. The world's largest miner, Brazil's Vale SA, also reported a 2.9% lift in production at its latest results – a new record.
The larger miners have also been closing high-cost and less efficient operations, trimming their expenses in order to focus on maintaining profits. It's an effort that hasn't been entirely successful, with Rio, BHP, and Fortescue Metals Group Limited (ASX: FMG) all posting significant decreases in revenue and profits over the past twelve months. Sure, they might still be profitable, but earnings will fall, which will drive share prices.
While this is obviously bad news for smaller, higher-cost miners, it's also likely to hurt the majors, as their costs are now lower and their production is higher. This means prices can fall further before becoming uneconomical, and are likely to fall further as increased production worsens industry oversupply.
Fairfax media recently quizzed Westpac senior economist Justin Smirk on the price of iron ore. He reportedly responded "Is there a risk iron ore can break out of its current range? We think so, and still have a low of US$45 a ton pencilled in for this year" (emphasis added).
Fellow Fool Mike King thinks that might even be optimistic, suggesting a price of between US$20 and US$30 a tonne is possible.
Given the massive hits to profit that iron ore miners have already sustained, investors should think twice before diving into the sector.
