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Why the Outlook on Iron Ore Is Still Negative

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Iron ore miners

BHP Billiton (BHP) (BBL) and Rio Tinto (RIO) have reduced their per-unit costs significantly over 2014 and 1H15. This is helping them remain profitable, even under the depressed iron ore price environment. On the other hand, Vale SA (VALE) still has a long way to go with the S11D project. This project will lower the overall production cost for the company. However, Vale needs funding to complete it. For pure plays and smaller players like Fortescue Metals Group (FSUGY) and Cliffs Natural Resources (CLF), the margin cushion left is too low at the current levels, making them much more sensitive to iron ore prices.

The SPDR S&P Global Natural Resources ETF (GNR) tracks the natural resources index. BHP and RIO form 6.7% of its holdings.

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Cost curve

Major iron ore producers are further reducing costs to weather the current market downturn. The mining costs are declining, though there have been some improvements from productivity gains, lower oil prices, and depreciating local currencies. High cost iron ore operators are exiting the market due to cost-cutting efforts by the majors coupled with expanding volumes. This in turn is pushing the cost curve for iron ore further down. This is also one of the reasons that the outlook for iron ore prices doesn’t seem very bright going forward.

Fundamental factors

In addition to this, as we previously discussed, supply side remains strong with no major slippage expected on plans from majors. China’s demand fundamentals remain weak. While the central bank and the government are taking steps to ensure steady economic growth, a positive impact has yet to be felt.

China remains the single most important market for commodities, and any negative outlook there could translate into weakness in commodities. While lower inventory level is one factor that could keep the iron ore prices steady in the short to medium term due to restocking, in light of the above factors, it is difficult to be positive about iron ore’s long-term fundamentals at this time.

For the latest updates, please visit Market Realist’s Iron Ore page.

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