Today I am looking at why I believe Rio Tinto (LSE: RIO) (NYSE: RIO.US) is on course to shuttle southwards.
Metal prices expected to continue dropping
Rio Tinto’s earnings profile has been whacked significantly over the past year, as deteriorating supply/demand balances across commodity markets have driven prices lower. And the latest World Bank report painted a bleak picture for the year ahead, with further price falls expected to hammer prices again during 2014 — base metal prices are anticipated to drop 1.7% in 2014.
As the World Bank noted, “if robust supply trends continue and weaker-than-expected demand growth materialises, metal prices may decline more than the baseline, with significant negative consequences for metal exporters.”
Dollar expected to climb in 2015
On top of this, the prospect of a stronger US dollar during the current year also threatens to push commodity prices to the downside. Of course commodities are priced in dollars, so any rise in the value of the world’s reserve currency makes raw materials more expensive to procure.
With the Federal Reserve expected to continue scaling back its quantitative easing programme, and the US economy showing continued signs of recovery, this is likely to add an additional millstone to Rio Tinto’s revenues projections.
Production continues to head skywards
Despite the creation of overcapacity across a multitude of key commodity markets in recent years, the mining community as a whole is failing to respond to this issue and cut payloads in order to prop up prices.
Yes, it’s true that a number of firms have slashed output in some markets in order to rebalance the market, after galloping demand from China following the 2008/2009 financial crisis prompted producers to ramp-up their operations. Indeed, Japanese trader Sumitomo announced this week that cutbacks in the aluminium sector specifically should push the market into a deficit of 37,000 tonnes next year from a 314,000-tonne surplus in 2014, according to Bloomberg.
However, the same cannot be said in most other commodity markets where production levels continue to head higher — indeed, BHP Billiton announced record output in metallurgical coal, alumina and iron ore during July-December. And Rio Tinto itself reported that galloping operations in Australia sent iron ore, bauxite and thermal coal output to all-time highs during the same period.
Until global output starts to head in the opposite direction, these impressive production milestones are set to hinder rather than help mining companies’ earnings performance.