REVEALED: Why the Rio Tinto Limited share price is falling

The Rio Tinto Limited (ASX:RIO) share price is being hit on the back of more troubles.

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Overnight, the London-listed share price of Rio Tinto Limited (ASX: RIO) sunk 8.4%.

Closer to home, against a backdrop of a 0.7% fall in the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO), Rio Tinto's share price traded down 4% in morning trade before recovering to negative 1.35% after midday.

Source: Yahoo! Finance
Source: Yahoo! Finance

Shares of the resources giant have been crunched in recent months, as key commodity prices like iron ore, copper, aluminium and coal continue to remain depressed. Falls in the market prices of iron ore, which is by far Rio Tinto's most lucrative commodity, have begun to cripple the profits of producers right around the globe.

Even the world's largest and most efficient operators can only watch on helplessly as their record revenues and profits dwindle.

Overnight, Anglo American plc, a $9.5 billion mining giant, announced it'd cut billions of dollars of assets from its balance sheet; axe 85,000 employees from a current 135,000; and suspended its dividend. Anglo American shares are down 73% this year alone.

It is never my intention to sound like a doomsayer, but doomsayin' generally follows a mining boom, that's all I'm saying (see what I did there?).

And if you want to know the magnitude of what the post-boom commodities market may look like, sketch out the next few years of the following chart in your head:

Data sourced from Indexmundi.com
Data sourced from Indexmundi.com

It doesn't look good, does it?

While Rio Tinto is heralded with some of the lowest-cost iron ore operations in the world, it won't be immune to a prolonged downturn in commodity prices. Judging by their announcements overnight, Rio's management recognise the market outlook as being bleak and are making provisions.

Overnight, Rio lowered its capital expenditure guidance (the money it plans to spend at its current mines and others) to $5 billion, "compared to previous forecasts of less than $6 billion."

"Our prudent capital allocation and disciplined approach to the balance sheet have reinforced our resilience during this period of ongoing volatility," CEO Sam Walsh said.

According to analysis from investment bank UBS earlier in 2015, Rio's estimated break-even price was $US33 per tonne.

Overnight, the iron ore price closed at $US38.80 per tonne, according to The Steel Index. Put another way, since the start of the year, Rio Tinto's estimated gross profit margin has fallen from roughly 104% to 17%. In Rio's last financial year, prices did not drop below $US68.80 per tonne (a 104% margin).

According to data from Indexmundi, back-dated till November 1985, the average monthly price of iron ore is $US40.30 per tonne. However, bear in mind those figures were recorded during the ramp-up of China's unprecedented infrastructure-led economic boom.

To put it in perspective, I like to call upon some data sourced by Bill Gates, the guy that started Microsoft. In June last year, he wrote on his blog, gatesnotes:

"China used more cement in the last three years than the U.S. used in the entire 20th century."

Therefore, if China is really slowing down from a never-before-seen economic boom, lower commodity prices could be here for a little longer than many investors expect.

Buy, Hold or Sell?

Relatively speaking (take a look at BHP and Anglo's share price over the past year if you don't believe me), Rio Tinto's share price has fared pretty well during the recent – but ongoing – commodity price rout. Unfortunately, although I believe it is a well-managed miner with a healthy exposure to other commodities, affording it diversification; I think there may be more pain in store for Rio Tinto shareholders.

Motley Fool contributor Owen Raszkiewicz has no position in any stocks mentioned. Owen welcomes your feedback on Google plus (see below), LinkedIn or you can follow him on Twitter @ASXinvest. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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