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China's Price Probe Drags Iron Ore Down From 5-Year High

Madhurima Das

The China Iron & Steel Association has urged the government of China to investigate and maintain order in the global iron ore market after prices surged to a five-year high amid supply constraints. The association wants prices back at normal levels. Iron ore prices, which have enjoyed a bullish run so far this year, were sent reeling on reports that Beijing is likely to crack down on irregularities, including sharp price increase and price manipulation. Iron ore prices dropped 1.25% to $115.65 on Jul 5. Earlier this month, iron had attained a five-year high to hit $126 a ton. Notwithstanding the dip in current prices, iron ore prices have gained 65% so far this year.

Supply disruptions, principally in Brazil after fatal disaster at Vale S.A’s VALE Brumadinho dam rupture at Córrego do Feijão mine triggered the iron ore price rally. Vale’s suspended operations, led to an estimated loss of annual iron ore production of about 92.8 Mt which represents around 6% of the total seaborne iron ore market each year. Further, bad weather negatively impacted iron ore supply from Australia. Consequently, supply disruptions from the world’s two largest iron ore exporters, Brazil and Australia, fueled apprehensions of an impending supply crunch, which in turn, aided the surge in iron ore prices.

China, which makes about half of the world’s steel, imports more than 70% of the world’s seaborne iron ore. Stringent environmental controls are pushing Chinese mills to go for higher-quality imported ore as opposed to domestic ore. Demand for steel will remains strong as China may roll out more infrastructure projects to improve its slowing economy. This demand supply imbalance will continue to drive iron ore prices.

In tandem with the iron ore prices, the Zacks Mining – Iron industry has rallied 5.7% over the past month, outperforming the S&P 500‘s and the Basic Materials Sector’s growth of 3.3% and 4.9%, respectively.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright prospects in the near term. The Zacks Mining- Iron Industry, currently carries a Zacks Industry Rank #5, which places it at the top 2% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Going by the EV/EBITDA multiple (a preferred valuation metric for mining companies that have high capital expenditures), the iron mining industry has a trailing 12-month EV/EBITDA multiple of 4.61, much lower than the S&P 500’s EV/EBITDA multiple of 11.04.

Thus, it would be a good time to invest in the industry. We suggest stocks like Fortescue Metals Group Ltd. FSUGY, Rio Tinto plc RIO and BHP Group BHP which sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. Shares of Fortescue Metals Group, Rio Tinto and BHP Group gained 105.4%, 23.8% and 17.2%, respectively, year to date. All these stocks have undergone positive estimate revisions for the current fiscal and also have positive growth expectations for the fiscal.

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