Risks Rising for Iron Ore Stocks

Chris Lau, Kapitall: Weakness in China's economy means less iron imports. Iron ore stocks may suffer from falling prices.

China's 18% export decline shocked the market. A steep sell-off in companies reliant on iron ore prices followed. The resource sector is not for the faint of heart. It is in a bear phase due to ongoing weakness in China’s economy, risks of a global slowdown, and fears that interest rates will rise.

Cliffs Natural Resources (CLF) and Freeport-McMoRan Copper & Gold (FCX) are two companies that are impacted by iron ore prices. Cliffs is falling faster than other iron ore plays because over the years it bought mines in anticipation of stronger demand from China. Conversely, Freeport diversified from the metal, and is now an oil and gas exploration play. Freeport took on more debt, but expects to grow revenues in the next few years.

Risk for Cliffs could accelerate

Leverage is either good or bad, depending on product demand. When iron ore demand was strong, leveraging assets through debt accumulation worked favorably. Weak Chinese exports could accelerate the cost to finance debt. If iron ore prices keep dropping, Cliffs should be expected to generate much lower profits. Still, China could devalue its yuan or introduce a stimulus. This would benefit Cliffs.

Wait for a bottom

With economic uncertainty in China rising daily, investors should be cautious with Cliffs. It would be better to wait for the stock to bottom first. Evidence that iron ore prices are stabilizing would also support a more positive view for Cliffs.

 

Click on the interactive chart to view data over time. 

 

1. Cliffs Natural Resources Inc. ( CLF): Produces iron ore pellets, lump and fines iron ore, and metallurgical coal products. Market cap at $3.27B, most recent closing price at $21.34.

 

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