Here in Australia, we are the largest iron ore producers in the world, so you can imagine we have a variety of iron ore stock options to invest in.
The production and exporting of iron ore is one of the largest contributing factors to our economy. Back in 2014, iron ore export revenues equated to $75 billion, providing a major source of income for the country.
In 2010, the metal outranked coal as Australia’s most valuable export by over $4 billion.
Iron ore is, simply put, the foundation metal of Australia’s export industry, and it has been for the past 10–15 years. It’s arguably been the biggest driver of our mining boom.
But it is economically significant in other ways, as well. For instance, the mining of it accounts for a decent chunk of Aussie employment.
Our three big producers — Fortescue Metals, BHP and Rio Tinto — are global market dominators, as well as being amongst the largest stocks on the ASX.
Today, iron ore still represents almost 20% of our exports.
With that in mind, let’s look at what may be in store for iron ore, and how you could potentially profit from it.
Let’s start with the bad news. The future of iron ore is looking rocky.
China is hell-bent on resolving their economic weaknesses. They are concerned about their serious debt problem, caused by too many insolvent operations. And the horrific amounts of air pollution in China is a notable environmental issue.
For these reasons, China is aiming to stop illegal and inefficient domestic mining of iron ore, because of its low-grade, loss-making results on their economy.
They’re also becoming stricter on excess steel-making — a sector with high demands of iron ore. Not only is it an environmentally-unfriendly process, but China are sick and tired of selling steel at prices that don’t make a profit.
Many of these steel producers have been operating at a loss for years and can’t repay their debts. Chinese authorities have had enough and are clamping down!
Obviously, this means a reduction in iron-ore demand.
While their actions may not directly affect the mining of iron ore, they will reduce China’s demand for it. And, as China is the biggest consumer of iron ore in the world, this means bad news for the resource.
Granted, there will always be a steel industry. But China wants only licensed operators producing steel. This is where the need for high-grade iron ore comes in. The low-grade stuff needs more energy to convert into steel, which means more toxic emissions — not ideal for a country wanting to minimise their pollution levels.
The Chief executive at Rio Tinto, Jean-Sebastien Jacques, states:
‘…there is no doubt that the restructuring of the [Chinese] steel industry is here to stay.
‘The push for environmental performance is there as well and therefore they will continue to reduce capacity. That doesn’t mean they will reduce production.’
But this high-grade iron ore, understandably, costs more. This means only the best of the best steel makers will survive. The ones who aren’t destroying the environment and aren’t constantly at risk of financial collapse.
In short, China wants to clean up its act…and its air.
Is it all bad for iron ore investment?
China’s clean-up is undoubtedly reducing their iron ore demand. But this also means heightened demand for high-grade iron ore. And because higher quality is more expensive, it’s the legal steel producers making money at these prices.
The result is likely to be a greater import of iron ore from Australia and Brazil, where there are higher grade reserves.
China is also moving from an investment-led economy — largely driven by building infrastructure which requires iron ore — to a consumer-led economy. But China is still using economic stimulus to keep the steel sector alive as it carries out this transition.
For example, China has recently approved a large steel project — the $14 billion expansion of a rail network.
After its peak in 2011 and collapse in 2015, the iron ore price has been volatile but has largely moved sideways. Right now, there’s just no reason for it to go significantly higher, thanks to China’s clean-up act.
Looking outside of China, there’s no significant demand for iron ore from any other country in the world.
That might change in the medium to long term as India builds multiple smart cities and the US re-builds its infrastructure. But the short term doesn’t look amazing for iron ore, and its price is likely to stay volatile.
However, there are still takeovers happening everywhere in the iron ore space…
Keeping a look out for the best iron ore shares to buy
During the low phase of a resources cycle, you often see a lift in mergers activity, as big players seek to snap up supply ahead of the upswing. We’re seeing a perfect example of this play out at the time of writing, with Atlas Iron Ltd [ASX:AGO] currently in the midst of a bidding war.
Mineral Resources [ASX:MIN] lodged a takeover bid for Atlas Iron on 9 April 2018, valuing the company at 3.02 cents per share. Fortescue Metals Group [ASX:FMG] then bought a major chunk in the company on 7 June.
On 6 August, Fortescue then sold their stake after a failed bid to block Hancock Prospecting taking over the miner. Hancock responded with a $390 million cash bid for Atlas, whose board is backing it as I write.
Atlas Iron has had a difficult past, given its leveraged balance sheet and high production cost. But the company has advanced, despite all odds. It has optimised its iron ore production profile, which has increased cash flow and reduced balance sheet debt.
How to buy iron ore stocks?
We suggest staying clear of the big players — such as Fortescue, BHP Billiton Ltd [ASX:BHP] and Rio Tinto Ltd [ASX:RIO] — for now. These are very exposed to the iron ore price. Instead, consider looking at possible takeover targets with huge growth potential.
For instance, in July of 2018, Brockman Mining [ASX:BSK]’s wholly-owned subsidiary Brockman Iron entered into a farm-in and joint venture agreement with Polaris — a wholly-owned subsidiary of Mineral Resources Limited [ASX:MIN]. Polaris has the option to farm-in and earn a 50% interest in the Marillana Iron Ore Project, located in Western Australia.
Marillana is an enormous, high-grade iron ore project. The joint-venture is a smart decision for the company. It reduces the maximum capital commitment to roughly $150 million for the company. That’s a lot more manageable, considering the company’s market capitalisation stood at $275 million in July 2018.
Provided the company proves its lucrative nature, shareholders could be significantly rewarded.
Stocks like this are worth looking out for.
We’ll keep you updated on all the latest on iron ore and Australia’s exports here in Money Morning. You can find all our latest articles on the topic here.