Right now, two freight trains are speeding headlong towards each other.

Trouble is, they’re barreling along on the same track – and when the collision happens in three to six months time, it won’t be pretty. Why?

Because one train is carrying the global supply of iron ore; the other is much longer and is carrying the demand for steel.

Yes, folks… we have another classic supply and demand scenario playing out. This one has an inadequate iron ore supply pitted against insatiable demand from China and other emerging market countries.

[ad#Google Adsense]The result? Like any other supply and demand crunch, prices for iron ore are surging – and will continue to do so for the foreseeable future. Here’s the deal…

Fundamentally Speaking…

As I’ve said here before, a modern, efficient infrastructure is crucial to every country’s economic growth. And a large part of that infrastructure depends on steel. Like copper (which I’ve pegged as my top energy and infrastructure investment idea), steel is critical to nation building.

And like copper, the price of steel ultimately filters down into the costs of everyday goods and services. Why? Because it’s found in just about everything we use: cars, buildings, bridges, pipes, factories, machinery and equipment, the list goes on.

And here’s the problem: Iron ore costs are up sharply. Most mines have raised prices by around 23% to 25%.

But as the old saying goes, “You ain’t seen nothin’ yet.”

How Long Could the Iron Gravy Train Continue?

In three months time, steel mills will be paying record prices for iron ore, as global demand continues to outstrip supply. And both industry executives and analysts expect to see much higher prices for the remainder of this year and well beyond.

For example, contract prices for April through June are slated to jump to $170 a ton for iron ore produced in Australia. That’s 45% higher than the same quarter a year ago and nearly 200% higher than the price prior to March 2010.

According to Colin Hamilton, a bulk commodities analyst at Macquarie, “[2011] is going to be phenomenal for miners.”

And if Vale CFO Guilherme Cavalcanti is anywhere close to the mark, it could continue for a long, long time.

He said recently that he expects supply constraints for iron ore to continue for at least three to four more years: “This is the greatest moment for the company so far, but the best is yet to come.”

So let’s put our investment hats on…

Iron Ore Price Inflation Spreading Across the Steel Industry

The price of iron ore is critically important to two of the world’s largest manufacturers: Mining and the steel industry.

Over the past month, BHP Billiton Limited (NYSE: BHP), Vale (NYSE: VALE) and Rio Tinto plc (NYSE: RIO) have all reported record 2010 profits. This is mostly due to soaring iron ore prices.

Iron ore prices are already affecting certain grades of steel, some of which have risen over 50% since last November. For example, scrap steel prices in Russia have risen by 10% since December, according to industry publication, Scrap Monster. From here, future scrap prices will likely track the rise in iron ore prices.

India Tosses a Steel Wrench in the Supply Chain

Adding to the supply and demand problem is the fact that India, the world’s third-largest iron ore producer, has banned iron ore exports. India’s central government says the ban is necessary in order to curb illegal mining activity and preserve supplies for future domestic needs.

That’s fair enough… but it doesn’t help the global supply problem.

[ad#article-bottom]So in order to combat the export ban, Arcelor Mittal (NYSE: MT), Russia’s Severstal and South Korea’s POSCO (NYSE: PKX) are all going right to the source. If they can’t get exports from India, they plan to build steelmaking plants in India itself. Trouble is, those plans are at least four to five years away.

Bottom line: Commodities are still king of the investment hill. With governments around the world printing money in an attempt to make other countries’ currencies more plentiful than their own, it all boils down to one thing for all raw materials: They’re going to skyrocket.

Smart investors will be heavily invested in them during the coming decade – and will be richly rewarded as a result.

Good investing,

— David Fessler

[ad#jack p.s.]

Source:  Investment U