Why iron ore’s recent gains won’t last long

The big trucks transport iron ore
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The price of iron ore rebounded overnight to a recent high of US$60 a tonne. That’s continued the trend of small gains since April.

The chart below shows that it’s been a good month for iron ore producers.

After bottomming out at US$47 per tonne at the start of April, the rebound will come as a relief for iron ore producers. With iron ore prices breaking the $60 barrier, producers have regained almost 30% of the losses they suffered between March and April.

Australia’s iron ore exports rose to 61.4 million tonnes in March. Despite the lower prices, exports are set to grow again this year. The 717 million tonnes exported last year was 134 million more than in 2013. And 2015 will be even higher, with projections for exports at 809 million tonnes according to investment bank UBS.

It’s also come as a relief for those in power. Both the federal government and the RBA will see it as a temporary boon to the flagging economy. More revenue for miners — however brief — is always welcome.

An increase in exports this year won’t make up for US$45 iron ore prices. At US$60 the situation looks better — but it’s temporary. And the mining giants are more worried about maintaing market share right now. So the good news isn’t likely to last.

Iron Ore

Source: Financial Review

The reasons for iron ore’s resurgence

BHP Billiton’s [ASX:BHP] decision to put a moratorium on its Port Hedland  project is the main reason prices have risen back above US$60 for the first time since February.

Both BHP and Rio Tinto [ASX:RIO] have been accused of oversaturating the market with excess output. Competitiors Glencore [LON:GLEN] and Fortesque [ASX:FMG] have both criticised the two Aussie giants over this in recent months.

And they’ve had the government in their corner too. That’s because the government is affected by lower prices — lower prices lead to less tax revenue.

Not that any of this latest criticism is rubbing off on investors, who have held firm since mid March — following a brutal few weeks when both Rio and BHP saw massive sell offs.

Why many investors are sticking by BHP and Rio even with low prices

BHP’s shares shed AU$9 between February and March. Rio’s shares also fell by AU$5 in the same period. That brief selloff has since flatlined. Both BHP and Rio have soothed investors by restating their commitment to increase their total market share whatever it takes. Investors also rewarded Rio’s share buyback scheme in February.

Investors are concerned about lower prices, but those holding onto them aren’t in a rush to dump holdings just yet. BHP and Rio are still posting healthy profits. Both companies also retain a progressive dividend strategy. BHP alone paid out AU$8.2 billion in dividends last year.

Iron ore price outlook for 2015

The recent gains in iron ore prices won’t last much longer. By the end of the year the price should settle back to between $45 and $50.

That’s because high production outputs at Rio and BHP will push prices back down. Even with the delayed Port Hedland project, BHP is still on course to ship 270 million tonnes this year, which will push down prices of the commodity. The market is just reacting to future iron ore production levels, even if production for 2015 remains relatively high.

If the Hancock Prospecting Roy Hill mine starts shipments this year too, then prices could drop below $45 by the end of the year.

As long as dividend yields remain strong (and it seems that they will), neither company  should drop too far below their current share price through 2015.

Mat Spasic,

Contributor, The Daily Reckoning

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The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.
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