Last week, the global copper market found itself in the throes of massive selling that led to copper contracts listed on the Shanghai Futures Exchange falling to their lowest levels in four years on Tuesday. London prices followed suit, tumbling that day to the lowest in three years.

Copper

A bond default by Chinese company Chaori Solar apparently spooked domestic financial markets, which feared that more such defaults were waiting to happen. Already grappling with tightening credit, the copper market, which traditionally uses physical inventory of the metal to secure financing, is said to have panicked after the release of disappointing Chinese economic data.

Fearing that copper prices could fall further in the event of low growth and hence weak demand, market operators apparently reduced their exposure by selling or hedging inventories.

Another factor: apprehensions that falling copper prices could lead to defaults by borrowers, forcing financers to unload metal collateral on the market, and unleashing a downward price spiral in a domino effect.

Weak economic data from China

Recent data from China showed a sharp slump in its exports, weak credit growth, and lower-than-expected growth in industrial production as well as retail sales.

The situation was exacerbated after Chinese leadership hinted that GDP growth was no longer a top national priority, and that government was also preoccupied with the need to step up reforms and lower risk in its financial markets.

Iron ore prices take their cue from copper

Iron ore prices, too, plunged to their lowest levels in four years following similar apprehensions about difficult credit, liquidation by financiers and a slowing economy.

The Chinese government has recently indicated that it will curtail credit to inefficient steel mills, resulting in a lower off-take of iron ore by mills and a pileup of inventory.

A report in The Sydney Morning Herald said iron ore prices (Benchmark Iron ore for immediate delivery to the port of Tianjin in China) crashed last Monday to below US $105 per tonne, apparently after Chinese steel futures suffered a sell-off. Analysts at Goldman Sachs expect the price of iron ore to average US $108 per ton this year and only US $80 per ton in 2015.

Mining companies put on a brave face

According to an article in Forbes, the larger mining companies such as Rio Tinto plc (ADR)(NYSE:RIO), BHP Billiton Limited (ADR)(NYSE:BHP) and Vale SA (ADR)(NYSE:VALE) are not unduly worried by the volatility in iron ore prices, maintaining that they have a long-term perspective.

They expect a Chinese steelmaking capacity in excess of 1 billion tons by 2030, resulting in sufficient demand for iron ore.

There is, however, an undeniable impact on their profitability in the shorter term.

How iron ore producers will be affected

“The iron ore price has moved down sharply this year on concerns about Chinese growth, credit availability and talk of financing deals inflating iron ore demand within China,” says a research note on breakeven prices for global iron ore producers by UBS analyst Glyn Lawcock and his team.

The research note extends the pricing coverage globally after the popularity of an earlier note covering Australian miners. “The analysis shows BHP and RIO having the lowest breakeven price of US$47/dmt cfr, while at the other end is Cliffs with US$103/dmt cfr (wtd ave of Aust-Canada),” says the report.

Clearly, the larger producers have the advantage of scale and therefore enjoy lower breakevens, as shown in the chart below. This means their operations continue to be viable even at low prices.

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