- Iron ore prices are relatively high, therefore, don’t expect earnings and dividend stability.
- An analysis of mining costs shows the balance price for the metal. Trade iron ore miners around that balance price.
- Vale’s mining costs per ton will go as low as $8.
Iron ore miners currently being praised as stable companies with low valuations, high earnings, and dividends, has really taken me by surprise.
But that’s how the market thinks. Short term, short term, short term, and a stock is a good buy only when it’s at multi-year highs because it’s the market performance that determines the quality, not the fundamentals.
That’s the nature of the current market, but don’t worry, there are still some old-fashioned analysts that like to look at fundamentals.
Figure 1: Rio Tinto, BHP, Fortescue, and Vale all trade close to multi-year highs. Source: Yahoo Finance.
All iron ore miners are far from their lows from a year and a half ago thanks to higher iron ore prices. However, one must be aware of the cyclicality of the iron ore industry and no one should base their investment decisions on just one year of relatively high prices.
Iron ore prices are extremely volatile, and moves up of 100% or down by 70% are the norm.
Figure 2: Iron ore are extremely volatile. Source: Business Insider.
Despite the volatility, it’s possible to invest in iron ore miners, but you have to be aware of the balance iron ore price, the factors that impact supply and demand, and that’s in addition to knowing the mining costs for the individual miners.
In today’s article, I’m going to give an overview of the industry and identify when it will be best to invest given the industry’s cyclicality.
Current Iron Ore Environment
Iron ore prices have quickly recovered from the 2016 lows of around $40 per ton to above $75, but since China increased its stance against pollution and limited some steel production, prices have begun to fall again.
The most important factor related to iron ore prices is global steel production and economic activity. This might surprise you, but demand from China is expected to decline by around 2.5% per year up to 2025 according to Morgan Stanley. Thus increased demand for steel and, consequently, iron ore will have to come from the development of other Asian countries like India, Vietnam, Indonesia, etc. Fortunately for steel producers, that’s the case now and they can expect rising demand despite the slowdown in China. However, any increase or decline in the speed of the expected Chinese slowdown will push iron ore prices lower or higher.
In order to determine a margin of safety when investing in iron ore producers, we have to take a look at cash costs. According to UBS, average all-in cash breakeven costs are at $60 per ton with Vale, BHP, and Rio leading the pack as the lowest cost producers.
Figure 3: Iron ore production breakeven costs. Source: UBS.
The thing is that those companies produce more than 60% of global iron ore and their costs are constantly declining while they are increasing production. This is logical as the big 4 are slowly pushing out higher cost producers in order to increase profits on volume. What long term investors have to keep in mind is that most producers are increasing production and lowering costs which is going to increase competition and push iron ore prices lower.
Figure 4: Rio’s Pilbara mine has costs below $14 per ton. Source: RIO.
Vale’s new S11D project goes even lower than Rio’s costs and is expected to reach a staggering $8 per ton.
Figure 5: Vale’s S11D project is expected to have cash costs of $8 per ton. Source: Vale.
Such low mining costs tell me only one thing, there is going to be a lot of volatility in iron ore prices and, consequently, in profits and dividends.
How & When To Invest
I always look for investments that are low risk and lead to nice rewards. Iron ore related investment are currently high-risk investments for a stable reward.
I wouldn’t exclude new gluts in the iron ore market that could push prices below $50, or even $40 per ton in the short term. When that happens, you should be a buyer because the market’s balance is above $50 and will eventually balance out and even go above balance for a short period of time as it’s now creating outsized profits for those who invested when iron ore was low.
Of course, there are lots of individual factors that will create differences between iron ore stocks, but the dividend seeking investor should look at other sectors as the risks are too high now.
Keep reading Investiv Daily as I’ll keep watching various markets and will definitely let you know when something is cheap and below long term balance prices to provide you with low risk – high return investments.