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Why I’d sell Fortescue Metals Group Limited and Rio Tinto Limited shares today

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Fortescue Metals Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO) are two of the most popular shares on the ASX.

But that doesn’t necessarily make them worthy stewards of your investment capital.

Of course, if you bought Fortescue shares in their infancy — when it was a speculative minnow — you would have done exceptionally well for yourself. However, in the post-Global Financial Crisis world, the harsh realities of mining have caught up with the shares of both companies.

Why I’d sell Fortescue and Rio Tinto shares today

In the long-term, mining is a competitive industry so the only way to differentiate yourself is by pursuing a strategy of cost leadership. Rio Tinto and Fortescue have worked diligently to ramp up production while also making their operations more efficient.

However, the same could be said of BHP Billiton Limited (ASX: BHP), Brazil’s Vale SA, Roy Hill and many others.

Indeed, companies across the entire sector have worked hard to cut unnecessary costs from their businesses, buying time for some of the higher cost producers to continue selling their product. 

Yet, for all their cost-cutting, a PWC report found that the value of mining shares had plummeted. “Market capitalisation is down 37% negating all gains from the commodity super-cycle,” PWC’s media release stated.

The resources sector may be an attractive source of profits when commodities are in hot demand and when their prices are rising, but that is something the companies themselves have no control over. That leaves investors susceptible to a sudden pullback as well.

Given that China’s rapid growth is now slowing, that does raise questions as to where commodity prices will go in the future. As such, investors may want to look elsewhere for opportunities that are weighted more in their favour…

Warren Buffett, the world’s greatest investor, once said you should treat every investment as if you could only make 20 in your life. Treat every investment as if it is your last.

Sure, the companies mentioned above have mines with lives spanning many years, but they also cost a fortune to service which leaves them extremely vulnerable when prices do fall. That raises the question as to why some investors feel the need to invest in the sector in the first place.

As the PWC report found, big miners will continue to survive long into the future. And Rio Tinto and Fortescue are likely to make profits for many years. However, it’s the economics of these businesses over time which should concern investors. 

Foolish takeaway

We’ve just experienced a mining boom, but in the five years to the end of 2014, shares in each of the world’s four largest iron ore miners decreased. Though some have already called a bottom in the downturn — suggesting that now is a good time to load up on shares of the miners — what happens if they are wrong?

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned in this article. You can follow Owen on Twitter @ASXinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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