Short-term traders might be finding value in the price of iron ore producers' shares but is it worth the risk?
For the past 20 years, Australia's economy has experienced healthy growth trends, fuelled by mining in Western Australia and Queensland. In recent years, investors have dumped shares in our biggest mining companies and it has been well justified, but that doesn't make them cheap.
Five years ago, BHP (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue (ASX: FMG) each made plans to increase iron ore production during the financial crisis and are now about to begin production at some huge projects. The most recent quarterly reports for BHP and Rio bumped up the share prices of our two biggest miners 10.4% and 7.5% respectively.
Source: Google Finance
Despite positive effects from the lower Australian dollar having a positive effect on costs and spot prices (which are measured in US dollars) and increased production rates, the price of iron ore, alumina and petroleum is likely to fall further.
The longer term macro environment will mean Rio's share price should contract despite the favourable foreign exchange rates buffering prices in the short term. This means that although there may be value for short term traders, investors (those looking for sustainable growth over five-plus years) should be sceptical of Rio's ability to turnaround its share price into a healthy upwards trend.
In February this year, the monthly price of iron ore was $154.64 and the company's share price was peaking above $70.
Rio Tinto drives around 80% of revenues from its iron ore division so as spot prices fall, the stock price is likely to come down. Analysts from Goldman Sachs and Macquarie Commodities Research believe iron ore could fall to around $80 to $88 per tonne in the mid to long term. Compared to its current price around $130 per tonne, it's still got a long way to go.
Foolish takeaway
Rather than asking should you buy Rio Tinto, the question should be: Should you buy Rio Tinto now? This Fool thinks the answer is no. Not because it is a bad business but rather because the price will likely trend lower in the next 5 years, meaning patience will save investor's money.
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More reading
- It's time to buy Mortgage Choice
- Should you buy iron ore stocks?
- BHP, Rio approve "milestone" Chilean project
- How will exploration cuts hurt our miners?
Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies.
