Did you know that iron ore is the world’s second largest commodity market by value after crude oil? Also, it accounts for about 95% of the total metal produced worldwide.
However, its production is concentrated in the hands of three big miners: Vale, BHP Billiton and Rio Tinto Group. These three miners account for over 66% of the total iron ore market share.
As far as the geographical location of iron ore, the world’s largest reserve is located in Ukraine, followed by Australia, Russia, China and Brazil. Around 98% of Australia’s iron resource is found in Western Australia. Nevertheless, the largest iron producers are China (39%), Australia (17%) and Brazil. Australia doesn’t have to fear its competitors too much – China uses iron for its own development projects and although Brazil’s iron ore is of better quality, Australia is closer to the fast developing, major Asian importers (India, China) and Japan.
The major Australian mining companies listed on ASX in this field are Rio Tinto (RIO), BHP Billiton (BHP) and Fortescue Metals Group (FMG).
What is iron ore?
Iron ore are rocks from which metallic iron is extracted. After extraction, iron ore is used in blast furnaces to make pig iron, which in turn is used for steel making. Cement manufacturing also requires small amounts of iron. As you probably know, iron is found in pipelines, railway trucks, motor vehicles, trains and ships.
An important part of steel industry is recycling. Worldwide scrap represents about 7% of furnaces “feedstock”, but the availability of scrap is not very dependable. The price of scrap moves in tandem with the price of iron ore, making it less attractive during periods of high prices. However, according to US Geological Survey (USGC) scrap hasn’t risen as much as iron ore prices compared to the 2003-2007 period. Some countries, such as the USA, have significant scrap consumption: about 60% of the raw steel production.
Trading Iron Ore
There aren’t future contracts available for iron ore, therefore you can’t trade it directly. The only why to participate in this market is by purchasing the stock of a company that mines it. Some of them have made enviable gains, for example Equatorial Resources Ltd (EQX), with a price appreciation of 1653% for the year because of a successful ongoing development in Republic of Congo. But you wouldn’t want to buy high and sell low, right? Going forward, the iron price will depend on the strength or weakness of the US dollar, potential Chinese growth slow down and instability in the Middle East. As always, long-term prices are dependent on supply and demand: iron ore production versus steel usage. The views on the short to medium-term iron ore prices are divided.
The Bulls
On the bright side, the Reserve Bank of Australia (RBA) believes that another 300 to 400 million Chinese will move into cities in the next 20 years, basically doubling the number of people who live in an urban area. If the growth of developing countries continues, then India, Vietnam, Indonesia and other Asian countries will keep urbanising and building railways, therefore demanding more iron ore. Let’s not forget that Japan needs iron ore to rebuild its infrastructure.
So far, the Australian iron ore mining companies have enjoyed huge profits considering that the iron ore price was at some point this year $US 175 per tonne while it costs about $US 30 to produce it. According to the Australian Bureau of Agricultural and Resource Economics and Science report, the iron ore mining sector did very well in 2010. Production and exports increased by approximately 10% while the earnings increased by 57%, mostly because of iron ore price increase. The bureau doesn’t expect the trend to reverse this year. For 2011-12 period the export value is projected to increase by about 12% while the prices to increase by 33%.
The Bears
According to Resource Capital Research, in US dollar terms, iron ore prices are above 20 and 50 years long-term moving averages, which opens the debate of the sustainability of this trend. When a CEO of a major company makes bearish comments, it may be wise to time to stop and listen.
BHP’s Billiton CEO, Marius Kloppers, admitted that ''Halcyon days are never forever.”
Even some bankers, such as Standard Chartered Bank, are loosing their faith in the boom: ''prices will face downward pressure” in the next few months because of increasing supply from Brazil and weakening global steel demand. Some will go even further and call the iron ore market a “bubble”.
For iron ore investors, this is a freighting comment coming from Baosteel Group Corp., China’s second largest steel producer. Xu Lejiand, Baoesteel’s chairman believes that “There is a bubble in this market, many are gambling, everyone who has money is rushing in to invest in iron ore. Some investors are simply making money by trading the iron ore projects before seeing actual output.” Of course, it is in Baosteel’s best interest to see the iron ore prices plummet, but that is another story.
Alexei Mojarov, UNCTAD (United Nation Conference on Trade and Development) official commented on a recent report issued by UNCTAD on iron ore that “this year and next year the world iron ore market will be characterised by tight conditions” and “in the future the supply will gradually catch up and prices will gradually decline from present extreme levels but will stay at a higher level than 2008.”
Side note:
As mentioned previously, iron ore is not traded on exchanges. However, some progress towards it has been made in the last two years. In March 2010 the three major miners, Vale, BHP Billiton and Rio Tinto and steel makers agreed to change the iron ore pricing system from Annual Fixed price contract to spot pricing, meaning that instead of annual fixing quarterly benchmark, the price is decided between miners and still manufacturers. You can see the remarkable iron ore price appreciation (almost 1300%) over last 10 years on the chart.
Source: Index Mundi
Resources
http://www.asx.com.au/research/steel.htm
http://adl.brs.gov.au/
http://www.abares.gov.au/
http://www.australianminesatlas.gov.au
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