Is the iron ore price set to crash to US$50 a tonne?

ASX-listed iron ore stocks could come under pressure this morning on the back of a warning that the price for the steel making mineral could crash to US$50 a tonne.

The analysts at Liberum Capital have cut their forecast for iron ore by 17% to US$75 a tonne for the second half of this calendar year and is predicting the commodity will fall by a third again in 2020, according to the Australian Financial Review.

That would be bad news for the BHP Group Ltd (ASX: BHP) share price, the Rio Tinto Limited (ASX: RIO) share price, and especially for the Fortescue Metals Group Limited (ASX: FMG) share price as the latter is the marginal player of the group.

Falling back to cost structure

The bearish call by Liberum is based on the belief that Chinese demand for iron ore has probably peaked along with the out-of-cycle rally in Chinese property construction.

The broker pointed out that iron ore is the only one of four major commodities that is still trading well above its cost structure and it sees limited price elasticity supply above US$50 a tonne.

If Chinese demand for iron ore is falling, there’s no reason why the price of Australia’s biggest export won’t fall back towards the cost of producing the commodity.

Don’t count on Chinese infrastructure spending to support the iron ore price too as Liberum pointed out that the last time iron ore fell to US$40 a tonne in early 2016, infrastructure and manufacturing investment in China were running at 15% and 7%, respectively.

The broker said that the iron ore sector is in a cum-downgrade cycle and as forecasts move from spot price to Liberum’s 2020 price assumption, it will trigger earnings before interest, tax, depreciation and amortisation (EBITDA) downgrades of between 35% and 55%.

Foolish takeaway

It won’t only be our iron ore majors that will feel the heat under this dire scenario. The federal government’s prized budget surplus will look out of reach too and the impact on the Australian economy will be significant unless housing construction comes roaring back to life (sadly that’s unlikely).

But before you hit the panic button, it’s important to remember that the iron ore price is volatile and has a long track record of proving analysts wrong.

No doubt the tragedy at Vale SA had given our listed miners an unexpected fillip, but the price of the commodity is also influenced by a range of other factors outside the realms of classical economics.

This doesn’t mean the iron ore price won’t succumb to a crash, but it does mean investors will need to pay closer attention to what’s happening in the iron ore market as this won’t only have an impact on our biggest miners.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. Connect with him on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019

Source link Finance News Australia

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