NEW YORK (TheStreet) -- The outlook for coal and iron ore producers is bleak amid a backdrop of rising oversupply and concerns around Chinese growth.
That's the assessment from several brokers and fund managers that have slashed their ratings on key energy stocks in the past few days.
The iron ore price has dived 17% so far this year to $111.90, its lowest level since October 2012.
A key trigger for weakness has been lower economic growth expectations for China, which consumes about two-thirds of the world's iron ore supply.
European demand is expected to remain weak this year while new supply comes on board from Australia, South Africa and Columbia. As a result, Australia's Bureau of Resources and Energy Economics said this week that it expected benchmark iron ore prices to average $110 a tonne in 2013 down from its previous forecast of $119.
UBS described downside risks for the iron ore price as "formidable" and said it expected significant supply growth from Rio Tinto (RIO), BHP Billiton (BHP) and Fortescue. The broker initiated coverage of Cliffs Natural Resources (CLF) with a neutral rating and 12-month target price of $20.
Goldman Sachs analysts noted industry talk suggested contract negotiations between Asian steelmakers and Australian coal producers could result in a second-quarter metallurgical coal benchmark under $130, well below first-quarter levels of $143. Confirming these fears, Macquarie Equities analysts said reports claimed Anglo Coal and Nippon Steel had agreed on a second quarter coal benchmark settlement of $120, well below estimates.
Macquarie said Walter Energy (WLT) was among the most exposed stocks in its coverage to these lower prices, with Arch Coal (ACI) and CONSOL Energy (CNX) less affected. Goldman's analyst Neil Mehta maintained sell ratings on Alpha Natural Resources (ANR) and Arch Coal, citing "the challenging coal price outlook, sharp downside to consensus and high leverage levels."
Nomura analyst Curt Woodworth is more upbeat on the outlook for steel equities than many peers, recently telling clients, "We believe steel prices are at a near-term turning point driven by accelerating construction demand and raw materials price stabilization." He has a buy rating over NuCor (NUE - Get Report), Steel Dynamics (STLD) and U.S. Steel (X).
More broadly, energy stocks have slipped 1.28% as a group since January after posting 10% over the past year. This compares to gains of nearly 20% for the S&P 500.
Optimists remain. "Energy stocks vs. the S&P have shown significant improvement over the past few days and are a great risk-reward play in a choppy sector," Greywolf chief market technician Mark Newton told TheStreet, referring to oil services, drilling and exploration stocks. But many fund managers continue to shirk the sector, awaiting a change in supply-demand dynamics and a broad shift in sentiment before jumping back in.
-- Written by Jane Searle in New York