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Iron Ore Prices Surge to 5-Year High on Supply Crunch Fears

Madhurima Das

A significant reduction in iron ore stockpiles in China and apprehensions of a supply crunch owing to a fatal disaster at VALE S.A’s VALE Brazil mine and Cyclone Veronica in Australia, have pushed iron ore prices to five-year highs. The price of the steel-making commodity is currently trending above $100 per ton and clocked a gain of 50% so far this year and 8% in the past month.

Far Reaching Impact of the Brumadinho Dam Disaster

On Jan 25, 2019, a tailings dam failed at Vale’s Córrego do Feijão mine, in the city of Brumadinho, killing around 300 people and causing extensive property and environmental damage in the region. Various Brazilian courts have ordered freezes, attachments, deposits and similar measures affecting an aggregate of R$17.6 billion ($4.5 billion) of Vale’s financial assets to secure the payment of damages resulting from the dam failure. Vale suspended various operations, either voluntarily or as a result of revocation of licenses or court orders, which is likely to result in an estimated loss of annual iron ore production of about 92.8 Mt. The company anticipates restoring 20 million tons of yearly capacity at its Brucutu mine in Brazil but is awaiting approval for the same.

Vale’s lost production represents roughly a quarter of Vale's annual production, and around 6% of the total seaborne iron ore market each year. This stoked fears of a supply crunch. On top of this, Cyclone Veronica negatively impacted iron ore supply from Australia. Consequently, supply disruptions from the world’s two largest iron ore exporters, Brazil and Australia, led to fears of an impending supply crunch, which in turn, aided the surge in iron ore prices.

Demand-Supply Imbalance in China

China, which makes about half of the world’s steel, imports more than 70% of the world’s seaborne iron ore. Chinese iron ore port inventories have recently hit two-and-a-half year lows while demand remains high, which provided further boost to iron ore prices. Stringent environmental controls are pushing Chinese mills to go for higher-quality imported ore as opposed to domestic ore. China’s crude steel output hit a record high in May, highlighting China’s continued demand for steel consumption. Demand for steel will remains strong as China may roll out more infrastructure projects to support its slowing economy. This demand supply imbalance will continue to support iron ore prices.

The iron-ore price rally led to a spike in share prices of iron ore producers like Fortescue Metals Group Ltd. FSUGY, Rio Tinto plc RIO and BHP Billiton Limited BHP gaining a respective 94.8%, 25.1% and 13.6% year to date. While Fortescue Metals Group and Rio Tinto sport a Zacks Rank #1 (Strong Buy), BHP carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In tandem with the iron ore prices, the Zacks Mining – Iron industry has gained 14.9% over the past month, outperforming the S&P 500‘s and the Basic Materials Sector’s growth of 1.3% and 4.3%, 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 #3, which places it at the top 1% 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.

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Fortescue Metals Group Ltd. (FSUGY) : Free Stock Analysis Report
BHP Billiton Limited (BHP) : Free Stock Analysis Report
Rio Tinto PLC (RIO) : Free Stock Analysis Report
VALE S.A. (VALE) : Free Stock Analysis Report
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