Iron Ore Price Surge on pending supply crunch

Iron-ore prices are currently trending above $100 per ton and clocked a year-to-date gain of 10%. A surge in coronavirus infections in Brazil has triggered worries of a supply crunch for iron ore, while demand in China remains strong. This has led to the price rally of the steel-making commodity. So far this year, iron ore and gold have been the only metals that have not suffered price slumps in the backdrop of the pandemic.

Surge in COVID-19 Cases in Brazil Puts Iron Supply at Risk

Per the latest figures, Brazil has registered 28,936 new cases of coronavirus, and a record 1,262 deaths in a day. This takes the total number of coronavirus cases in the country to 555,383 and the death toll to 31,199. Brazil has now been marked the second worst-hit country by the virus.

Considering that Brazil is the world’s second-largest exporter of iron ore, the worsening COVID-19 situation has triggered worries that it might curb iron-ore supply. In April, Brazilian miner Vale S.A VALE trimmed its 2020 iron-ore production guidance to 310-330 Mt from the prior 340-355 Mt, citing the impact of the COVID-19 pandemic as one of the reasons.

Recently, Vale won an injunction from a court to maintain production in the Itabira mine, quashing an order issued by the Brazilian labor authorities to close the site due to the high number of coronavirus cases in the region. Notably, Itabira churned around 36 million tons, or 12% of Vale’s total iron-ore output last year.

The rapid spread of coronavirus in Brazil raises concerns regarding the iron-ore supply in the near term, even though mining has being allowed to operate as an essential business. Rising infections among workers might result in a reduced workforce, limit productivity or even lead to closure of mines.

China Showing Signs of Recovery

The Official NBS Manufacturing PMI in China was 50.6 in May 2020 — the third straight month of increase in factory activity, as companies resumed operations. This indicates a major rebound from the all-time low PMI reading of 35.7 in February amid the coronavirus-induced lockdown. This suggests that China is gradually moving out of the crisis and is working toward full normalization of economic activity.

China, which makes about half of the world’s steel, imports more than 70% of the world’s seaborne iron ore. China produced 996.34 million tons (Mt) of crude steel in 2019, just shy of the 1 billion mark, per the National Bureau of Statistics of China. The figure also marked an improvement of 8.3% over 2018. China produced around 85 Mt of crude steel in April 2020, up from the 79 Mt witnessed in March, taking the total steel production to 318.7 Mt for the January-April time period.

Per the China Iron & Steel Association, China is likely to see a strong recovery in steel demand henceforth, as the country’s infrastructure investment and production resumption gains more momentum. Thus, the demand for iron ore is expected to remain strong.

In tandem with the iron-ore prices, the Zacks Mining – Iron industry has gained 35.3% over the past month, outperforming the S&P 500’s and the Basic Materials Sector’s growth of 8.7% and 15.5%, 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 #20, which places it at the top 8% 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 3.78, lower than the S&P 500’s EV/EBITDA multiple of 11.56 and the Basic Material Sector’s 9.23.

The impending supply-demand imbalance is expected to flare up iron-ore prices, which bodes well for iron miners, like Fortescue Metals Group Ltd. FSUGY, Vale, BHP Group Limited BHP and Rio Tinto plc RIO. The combination of higher iron-ore prices and lower oil prices, which make up significant portion of miners’ costs, is likely to translate into improved operating margins and higher free cash flow this year.

Fortescue Metals Group, Vale, BHP and Rio Tinto gained a respective 44.6%, 35.3%, 28.9% and 27.7%, in the past month. While Fortescue Metals Group carries a Zacks Rank #2 (Buy), Vale, BHP Group and Rio Tinto have a Zacks Rank of 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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