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How Is Cost Deflation Supporting Lower Iron Ore Prices?

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Weaker local currencies

Most of the revenues for resource exporters are in US dollars while costs are in domestic currencies. Any weakness in domestic currency offers a cushion to companies in terms of cost benefits. The Australian dollar has fallen by 13% while the Brazilian real has fallen by 33% YTD (year-to-date) against the US dollar (UUP). The outlook remains bearish due to diverging monetary policies and the relative strength of the US economy as compared to the resource-driven Australian and Brazilian economies.

All other things being equal, a further depreciation of the Australian dollar and Brazilian real would tend to support costs for producers such as BHP Billiton (BHP), Rio Tinto (RIO), Vale (VALE), and Fortescue Metals Group (FSUGY).

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Lower freight rates

Shipping costs have fallen right along with the falling price of iron ore. China’s slowing demand is sapping demand for cargoes and this negatively impacts shipping rates.

The Baltic Dry Index (or BDIY), a measure of shipping costs for dry goods, has been falling to set record lows in the last few weeks. Charter rates for the Western Australia–China route fell to $3.25 per ton on December 18, the lowest level since December 2008. Rates for the Brazil–China route fell to $7.1 per ton on December 18. Lower freight rates help iron ore companies that are engaged in seaborne iron ore trade.

Other cost benefits

In addition to above, falling energy prices (USO) have positively benefited producers’ costs. This has led many producers to reduce their unit costs significantly. Vale highlighted iron ore cash costs of $12.7 per ton in its 3Q15 results. This was aided by foreign exchange and lower consumable costs along with productivity measures. Fortescue has also been improving its mine plan to optimize its cost structure.

These costs would further lead to a lowering of the marginal cost of iron ore production, thus supporting lower iron ore prices.

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