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Will Iron Ore Stocks Sink Like a Stone?

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BHP Billiton, Rio Tinto, and Vale are all down on low prices and diminished demand. Yet there's $200 billion of development currently in the pipeline globally for new iron ore mines.

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MINYANVILLE ORIGINAL Concerns over demand from China have weighed on iron ore prices this month, and the world's largest producers of the raw material ended May in the red. But some say sentiment could improve in the second half of this year. It's not clear if sentiment alone, however, can prop up the sector.

Laura Brooks, senior consultant, steel raw materials at CRU Group in London says weaker Chinese underlying demand, coupled with plentiful supply and ample stocks drove the iron ore market downward in May, as falling steel prices in China weighed heavily on sentiment in the iron ore market.

Iron ore prices fell from September 2011 levels of around $180 per ton to $138 by the end of the fourth quarter, according to data from The Steel Index and Bloomberg, on weaker demand. Although prices climbed back to $148 near the end of April, May has been a different story, with prices falling to $130 earlier this month.

"Iron ore prices thus fell back after reaching modest highs for the year in April, although they are now finding some stability," Brooks says.
Following substantial share price declines in 2011, year-to-date, Vale (VALE), the world's largest producer of iron ore, is down 14%, while BHP Billiton (BHP) has fallen 12.8%, and Rio Tinto (RIO) has moved 10.8% lower (to May 30).

"Iron ore stocks have been retreating as general consensus is that China growth has been slowing and considerable production is coming down the pipeline," according to an April research note on the iron ore sector by the analyst team at Dundee Capital Markets.

As reported by The Australian, Wood Mackenzie principal iron ore analyst Paul Gray noted earlier this month that Chinese buyers of iron ore "appear to be holding back on purchases amid increasing global economic uncertainty" and are also deferring shipments, leading to an oversupply in seaborne markets.

Long-term, Dundee analysts say they believe China's "breakneck pace of growth" is unsustainable.

"It has already showed signs of diminishing with Q1/12 GDP growth falling to 8.1%, compared to 8.9% the prior quarter. Combined with potential oversupply we may see serious downward pressure on iron ore prices. China consumes more than 60% of the 1 billion ton annual seaborne iron ore trade, and therefore remains the largest influence on prices," says Dundee.

While "short-term blips in production" from Rio Tinto, BHP Billiton, and Vale due to weather kept prices elevated in earlier this year, Dundee notes that more than $200 billion of development is currently in the pipeline globally for new iron ore mines.

"Producers are looking to develop economies of scale in anticipation of a slowdown in demand…but this a double edged sword, as excess supply will likely have an effect on iron ore prices. Consensus is that we may see this additional supply hit the market by late 2014, causing saturation and downward pressure on the metal," say Dundee analysts.

In a recent Commodities Compendium on iron ore, Macquarie analysts noted that the persistent supply struggles, coupled with grade degradation at existing assets, "highlight the challenges in bringing incremental iron ore supply to market and a need to discount heavily potential future growth."

So what lies ahead for the sector in the shorter-term?

When it comes to the miners themselves, Reuters reported that Rio Tinto's iron ore chief executive Sam Walsh said earlier this month that China's market for iron ore is "steady as it goes" in the short term. Vale's head of investor relations also reportedly noted that the miner is selling iron ore nearly as fast as it can mine it, in spite of a slowdown in China's economy.

Analysts at Dundee say that although they remain bearish on prices in the long-term, they are keeping their near-term estimates within the US$140 to US$150 per ton range through 2014.

For the remainder of the year, Brooks says she expects Chinese hot metal production -- and therefore iron ore demand -- to post quarter-on-quarter increases in Q3 and Q4, while supply from traditional hubs, particularly Australia, is expected to accelerate.

"In the short term, once the high crude steel production volumes of March and April are absorbed, we expect this to lead to an improvement in market fundamentals, lifting sentiment and providing support for iron ore prices," says Brooks.

She adds, however, that with the large degree of uncertainty around the strength of end-user demand in regions like China and Europe, a recovery in sentiment is likely to be gradual.
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