The Rio Tinto Limited (ASX: RIO) share price has been a raging bull these past 12 months, but it could be time to pull on the reins.
Rio Tinto share price
Rio Tinto shares (the blue line) have thumped the broader sharemarket, or S&P/ASX 200 (Index: ^AXJO) (ASX: XJO), over the past year. Meanwhile, rival BHP Billiton Limited (ASX: BHP) is up 27%.
Just this week, Rio Tinto shares hit a six-month high as iron ore prices climbed to a four-month peak.
Why I cannot buy Rio Tinto shares
As I noted earlier this week for BHP, mining companies should have performed better over the past 15 years for shareholders given that Australia — and the world — has experienced an unprecedented mining boom, thanks to China.
However, the long-term returns from Rio Tinto and its peers have been underwhelming.
Candidly, I think it's because the business struggles to earn exceptional returns on the capital it invests. That's the problem with every commodity business.
For example, if the iron ore Rio Tinto produces is the same as the iron ore which BHP Billiton produces, which ore would you buy? The answer: the cheapest one.
Prices will be okay if supply and demand are in balance. But markets are rarely that stable. And even if demand is flat, new ore supply will enter the market (lowering prices) until the miner's profit margins are eaten away.
Ultimately, low-cost miners are removed. However, in the meantime, those companies will continue to dig up and sell their product at a loss, trying to weather the storm. That takes its toll on market prices and, in turn, the profits of companies like Rio Tinto.
With a recent dip in iron ore prices and a subsequent rally, it's clear some supply has been taken out of the market.
But prices will not stay this high for long. And, longer term, we have the issue of China's waning demand for raw materials.
Foolish Takeaway
If you are a long-term investor do yourself a favour and only buy shares in companies that have great 'economics'. That is, buy companies that have strong brands, the ability to set the prices of their products by controlling supply and demand, and great balance sheets.
There are over 2,000 companies on the ASX. You should only buy the best.
