The Iron Ore End Is Nigh

I've been writing profusely about the dangers that lurk in the steel, copper and iron ore markets, due mainly to three factors related to the China slowdown:

• The drop in auto production in China;
• The drop in home prices in China, which portends a drop in residential construction;
• And the approaching drop in shipbuilding, due to incredibly low freight rates.

I've already shown that steel prices are locked in a down trend, which is confirmed by another look at the steel contract traded on the LME:

But now, beyond these speculative factors, there is something new: Bloomberg updates the stocks of iron ore on Chinese ports every Monday, and what did we see this Monday? This ...

We've seen a spike in inventories, although not quite as large as the one seen in May which broke the iron ore uptrend that existed up until then, and then led to the plunge in iron ore prices seen below, but still a relevant spike.

Also, this spike in inventories can be seen as part of a much larger trend toward higher inventories, a part of which is certainly warranted by the increased steelmaking activity, but leaves the problem as to what will happen if and when such steelmaking activity drops - as it is predicted to do now.

Conclusion

Iron ore prices should resume their downtrend in the short term, with negative implications for the quoted iron ore suppliers, namely Rio Tinto (RIO), VALE S.A. (VALE) and BHP Billiton (BHP).

These companies, known as the big three iron ore suppliers, trade at seemingly low valuations (TTM P/Es of 6.1, 7.6 and 9.6 for VALE, RIO and BHP respectively). However this should be a value trap, as the companies are very levered to the iron ore price and said price is expected to plunge due to the fall in Chinese steel production and the accumulated inventories discussed here.

Regarding the timing, the negative impact should be immediate. As for a positive cycle, a positive turn on automobile production in China could happen within months, but the residential construction slump as well as the shipbuilding slump will probably take a couple of years to sort themselves out.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.