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Volatility in iron ore price might hurt BHP, Rio Tinto shares, analysts say

With BHP Group and Rio Tinto releasing quarterly production figures during the week ended Oct. 18, analysts said a potential downturn in the price of iron ore could impact the companies amid signals of weaker demand in Chinese markets.

It is time to "hold fire" on major iron ore miners and wait for a better entry point as near-term volatility in prices for the commodity could uncover a better buying opportunity for investors, Australian financial advisory Morgans said in an Oct. 17 note.

While the Brazilian and Australian seaborne supply is recovering, signals including falling Chinese steel prices and deteriorating economic conditions in China indicate "a difficult price environment" for iron ore, which is already trading about 40% above the marginal cost of production, analysts at Morgans wrote, adding that shifting fundamentals in the iron ore market will likely cause some short-term share price pressure for BHP and Rio Tinto.

Morgans highlighted uncertainty in iron ore demand and prices as a significant risk for Rio Tinto. "This is particularly important for Rio Tinto, given a [plus or minus] 10% move in iron ore price impacts EBITDA by US$1.57 billion," the analysts said.

Commenting on the rebound in iron ore production from Rio Tinto's Pilbara operations, Morgans said it had expected some "hangover of operational issues" that affected its first-half performance, which added to weather impacts earlier in the year. According to an Oct. 16 note by analysts at Sanford C. Bernstein, the question is whether and how the company could increase total iron ore production to 360 million tonnes in the next few years.

Regarding the update from BHP on US$345 million in funding for its preproduction-stage Jansen development in Saskatchewan, Canada's BMO Capital Markets said Oct. 17 that it remains skeptical of the market's ability to absorb the output and that the market may be balking at this and the estimated US$5.5 billion capital commitment. Bernstein noted that the investment decision at Jansen was given a clearer timeline and will allow for a quick transition from planning to execution.

Commenting on Rio Tinto alumina and bauxite production, Bernstein expects a refinery maintenance campaign in the Pacific region, which affected operations in the third quarter, to stretch into 2020.

Looking at the companies' copper operations, Bernstein and Morgans were optimistic about BHP's early-stage Oak Dam project in Australia, where exploration work continued into a second drilling phase and returned multiple intercepts of high-grade copper mineralization.

As for the company's Olympic Dam copper operations in Australia, BMO said it remains unconvinced that the mine will be able to deliver on medium-term expansion plans to achieve the lower end of a production target of 180,000 to 205,000 tonnes.

Regarding Rio Tinto and copper, Bernstein noted a lack of news from the company on issues at the Oyu Tolgoi development in Mongolia, a joint venture between Rio Tinto's 51%-owned Turquoise Hill Resources Ltd. and the government of Mongolia. Bernstein also highlighted permitting progress at Rio Tinto's preproduction-stage Resolution joint venture with BHP in Arizona as well as positive performances at its Escondida copper joint venture with BHP in Chile and its wholly owned Kennecott copper mine in Utah during the third quarter.

Bernstein set target prices for BHP of 1,800 British pence, US$46.41 and A$36.70, while BMO expects its share price to reach 1,850 British pence and Morgans decreased its BHP price target to A$35.82 from A$36.66 per share.

For Rio Tinto, Morgans increased its target price slightly to A$91.64 per share from A$91.52, while Bernstein tagged the company's stock with target prices of 5,500 pence and US$78.78.