Iron-ore prices have surged to around $110 per ton — levels last seen August 2019. The steel making commodity has gained 17% year to date, stoked by apprehensions of a supply crunch owing to the worsening coronavirus situation in Brazil while demand in China continues to pick up.

Recovery in China to Fuel Iron Ore Demand

China, which makes about half of the world’s steel, imports more than 70% of the world’s seaborne iron ore. In June, imports to China grew 2.7% year over year to $167.15 billion — a turnaround from the 16.7% decline witnessed in May and the first increase in shipments into the country this year. The June imports also surpassed the market consensus of a 10% fall. Iron ore imports surged 35.3% to 101.68 million tons during the month — the highest since October 2017 and up from 87.03 million tons in May.

Also, the Official NBS Manufacturing PMI in China was 50.9 in June 2020, maintaining the streak of four consecutive months of increase in factory activity as companies have resumed operations following the easing of government imposed lockdown. This is a major recovery from the all-time low PMI reading of 35.7 in February, which can be attributed to the coronavirus-induced lockdown.

These figures indicate that China is gradually moving out of the crisis. The country is likely to see a strong steel demand henceforth as it ramps up infrastructure investment and production gains more momentum. Thus, the demand for iron ore is expected to remain strong. The World Steel Association expects Chinese steel demand to increase 1% in 2020.

Coronavirus Situation Puts Supply at Risk

Per a Reuters report, Port Hedland in Australia shipped a record 46.2 million tons of iron ore to China in June, up 7% on a sequential basis and 10% on year-over-year basis. Meanwhile, the aggravating COVID-19 situation in Brazil — the second largest producer of iron ore — has triggered concerns that it might constrain iron-ore supply. With coronavirus case tally at around 1.9 million and death toll at 72 100, the country is currently the second worst hit country by the virus. Rising number of infections among mine workers has triggered concerns that it might result in a reduced workforce, limit productivity or even lead to closure of mines.

Near-Term Outlook of the Industry Bright

The Zacks Mining – Iron industry has gained 32.7% over the past three months, outperforming the S&P 500’s and the Basic Materials Sector’s growth of 13.1% and 27.3%, 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 #1, 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 3.85, lower than the S&P 500’s EV/EBITDA multiple of 11.72 and the Basic Material Sector’s 9.51.

The impending supply-demand imbalance is expected to keep supporting iron-ore prices, which bodes well for iron miners. Further, 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 Ltd. FSUGY, Vale S.A VALE, BHP Group BHP and Rio Tinto plc RIO gained a respective 58.1%, 42.6%, 35.6% and 30.9%, in the past three months. All of these stocks currently sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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