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Is It the Right Time for Miners to Shore Up Their Balance Sheets?

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The iron ore price rally

Commodities (COMT) have rallied in 2016 despite many analysts believing the contrary. Iron ore, in particular, enjoyed a spectacular run from Chinese New Year through April. Iron ore prices saw their biggest one-day gain of 19% in March. April saw prices rise above $70 per ton compared to a low of $38 per ton in December 2015.

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Leveraged companies outperform

This rise in commodity prices led to the rise of mining companies’ stocks, too. Mining companies with higher financial leverage have gained the most in this rally. Anglo American (AAUKY), Glencore (GLNCY), and Fortescue Metals Group (FSUGY) have led the price rally. Glencore, Fortescue Metals Group, and Freeport-McMoRan (FCX) have risen 67%, 72%, and 77%, respectively, on a year-to-date basis, as of June 8, 2016.

During times of rising prices, companies with higher financial and operating leverage benefit the most and tend to outperform their peers.

Opportunity to reduce debt

Higher commodity prices have provided an opportunity to miners with high debt to reduce their debt burden. Not many miners believe that the strength in iron ore prices can be sustained in the long term. While restocking-driven demand is taking prices higher in the short term, the second half of the year could see supply increasing as Vale’s (VALE) S11D project and Roy Hill start delivering additional volumes. This could be negative for prices. For this reason, miners are still very cautious and are focusing on cutting costs, selling assets, and deleveraging.

In a similar move, Rio Tinto (RIO) announced the buyback of $3 billion of its notes. In this series, we’ll delve deeper into the debt buyback details and the impact it could have on the miner.

Read Market Realist’s Why Is the Iron Ore Price Rally Losing Steam? for more on the drivers of iron ore prices.

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