Here's How Iron Ore Could Rally Big...In 2018

In a new report, Morgan Stanley analyst Menno Sanderse suggests that leading global iron ore producers borrow a page out of OPEC’s book to stimulate a recovery in prices by 2018. However, this strategy would lead to multiple years of price weakness in the short-term.

The four largest global suppliers have invested in expanding their capability as of late. But a combination of ramping production and Chinese demand weakness have produced a market imbalance that could continue to hurt iron ore producers for years to come.

Morgan Stanley tested several different production scenarios for the top players to determine if any of them would improve their pay-off in coming years compared to the status quo.

“Our work indicates that not only do the big miners of the highly consolidated seaborne ore trade have the ability to individually/jointly alter their market’s dynamics, there may even be a financial incentive to do so,” Sanderse explains.

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The optimal strategy involves ramping up production in the short-term to drive the higher-cost producers out of the market before easing supply until it's in-line with market demand.

In the short-term, through 2017, Morgan Stanley expects all of the top names to remain under pressure from low prices.

Morgan Stanley has downgraded Rio Tinto plc (ADR) (NYSE: RIO) from Overweight to Equal-Weight. In addition, the firm maintains Overweight ratings on BHP Billiton Limited (ADR) (NYSE: BHP) and BHP Billiton plc (ADR) (NYSE: BBL) and an Underweight rating on Vale SA (ADR) (NYSE: VALE).

Disclosure: the author holds no position in the stocks mentioned.