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  1. Home
  2. / Investing
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Why Iron Ore Is Up 20% This Year

With Vale's Brucutu mine offline, the three remaining miners are churning more cash, making them attractive investments.
By MALEEHA BENGALI
Feb 11, 2019 | 06:15 AM EST
Stocks quotes in this article: VALE, RIO, BHP

Iron ore, once a very keenly traded bulk commodity, has been quite boring for the past year, as prices in 2018 averaged between $60-$70 a ton -- closing at around $71 a ton, down around 3.5% for the year. Today, the price of iron ore has jumped to a two-year high above $90 a ton after Vale, the world's top producer of the raw material used to make steel, was ordered to stop production at its mines following a horrific dam collapse in Brazil last month. Iron ore is up 20% so far this year and is one of the best performers in the commodity spectrum.

Vale has halted production at its mine, Corrego de Feijao. Last week, Brazil's State Secretary for Environmental and Sustainable Development revoked Vale's license to operate at its 30 million ton a year Brucutu mine, which will cut its production by 10%. On Tuesday, it said it would close a further 10 dams similar to the one that failed to prevent further catastrophic damage. This puts a significant amount of pressure on Vale following a tragedy three years ago when another damn jointly operated between itself and BHP Billiton near Samarco caused a terrible environmental disaster. Suspending production will cost Vale about £1 billion over three years. But further investigation will need to be carried out to find the cause and any additional liabilities the company may have to endure. 

Most analysts expected a small surplus in iron ore this year, but those forecasts will now be revised. In the global scheme of things, a total loss of 50 million tons this year is less than 3% of total global iron ore world supply, which is not a lot, by itself, but should keep prices elevated for now. The bigger question is how long Brucutu will remain closed. 

The iron ore market is dominated by four players: Vale (VALE) , Rio Tinto (RIO) , BHP Billiton (BHP) , and Fortescue Metals Group (FMG). Vale is currently the number one supplier of global sea-borne iron ore at around 24% of global supply, Rio Tinto is not too far behind at around 23%. As prices remain elevated, this will boost the share prices of these other dominant players who will be maximizing production.

According to UBS, there will be huge windfalls for Rio Tinto and BHP Billiton as a $10/ton rise in iron ore price boosts their cash flows by $1.9 billion and $1.6 billion, respectively.

According to Barclays, if Brucutu does not restart quickly, prices could go even as high as $100/ton, at which point production in the top quartile of the cost curve would be incentivized to come on stream. The longer this production remains shut, the more these companies will prove to be the main beneficiaries, adding to their already existing 4%-5% dividend yield stories.

The iron ore market benefitted greatly last year as the demand from steel companies was high, given the lucrative steel margins, making production profitable. Platts reported margins for HRC and Rebar at 53% and 78%, respectively, last year, which created 20% EBITDA margins for some Chinese steel companies. Hence crude steel output averaged at high levels around 80.8 million tons in the third quarter, falling down to 78.7 million in Q4. There is always a seasonal decline going into the Chinese New Year, which ended officially this week, allowing destocking and then restocking to take place. 

One thing is certain, the loss of Vale tons is of high grade quality. But some steel companies are sourcing lower-quality ore to make up for the shortfall, which is narrowing the spread between the different grades. Needless to say, prices are higher across the board. Until we know for sure when production returns, iron ore prices should hold at high levels until supply can return to offset the loss of these tons or demand collapses.

With each passing day, the three remaining miners are churning more cash making them attractive investments. If US/China trade talks go well this week ahead of the March deadline, together with the Chinese fiscal stimulus in place, these shares can surge even higher.

For now, don't fight the liquidity gravy train. Valuations are on your side, now fundamentals are too.

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TAGS: Commodities | Futures | Investing | Markets | Stocks | Metals & Mining

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