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Darwinism & Iron Ore Mining

|Includes: BHP, Cleveland-Cliffs, Inc. (CLF), FSUMF, RIO

The iron ore mining industry is facing its worst period ever, having fallen by more than 57% over the last 12 months. After enjoying a decade of tremendous growth thanks to the massive growth in steel demand from China, iron ore now seems to be facing an uncertain future, with its key players thrown into a quasi-Darwinian struggle for survival.

Should we really be surprised at this mineral's sudden downfall? Arguably, the foundation for the current slump was laid a few years ago when the market was flooded by supply from numerous small and marginal players, especially in China, India and Western Australia, all vying to meet China's infrastructure appetite.

Iron ore prices began declining more than six months before the oil glut, with the first signs of downtrend already noticeable in December 2013. The current strategy of the larger players to bleed their smaller competitors into extinction by over-producing has also contributed to further declines. What many did not contemplate until fairly recently was China's move to transform itself from an export/infrastructure-oriented economy to one dependent on domestic consumption.

At this time, the market does not believe iron ore has hit bottom yet (currently at $48 per ton) and could drop to $40 over this year or the next. The question is who survives this "not-so-natural selection" process. In this case, the dinosaurs of the mining industry, namely Rio Tinto, BHP Billiton and Vale, may end up being the survivors as they seem to have enough liquidity. The weaker players, especially in the fragmented market of China and India, are already suffering from closures.

Another group of companies that may make it out of this cyclical trough would be those that have cash to burn for two to three more years, or have quickly moved towards leaner operations. Companies like Fortescue Mining Group (Australia) and Cliffs Natural Resources (U.S.) should be interesting to watch. Their 2019 and 2018 bonds are trading at spreads of 1,370 and 1,688 basis points over Treasuries, respectively. Both companies are focusing on specific assets, giving up on foreign, non-performing or non-core assets. But both companies still face significant headwinds-Fortescue on the domestic front and Cliffs due to foreign competition.

Although troubles in the energy sector have gotten most of the coverage from the financial press, the iron ore industry's current plight is no less severe, with the current battle for survival favoring the larger, better capitalized players. As always, interesting relative value opportunities will arise from this sector's retrenchment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.