Shares in miners tend to be a bit cyclical. They’re entirely dependent on world metal and mineral prices, and that in turn is driven by a balance between supply and demand that is often on a knife edge.
A few short years ago, for example, there seemed to be a bit of a glut in iron ore supplies, and when you couple that with fears of a Chinese slowdown, it’s easy to see why Rio Tinto (LSE: RIO) (NYSE: RIO.US) shares have had a rough time — more than 45% of Rio’s 2013 turnover came from iron ore.
But I reckon Rio Tinto is undervalued now, and here are three reasons why:
1. Cycles are short term
While it’s understandable for profits from miners to be cyclical, to my mind it’s just nuts to chase the share price up and down along with them. So rather than fretting over the way the Rio price has followed economies and commodity prices in the short term, we should instead look to the longer term — and over 10 years, Rio is up 200% against 60% for the FTSE.
And with the shares on a forward P/E of 11, the valuation is not excessive at all, especially not with dividend yields approaching 4% expected.
2. No glut
While many were expecting an iron ore mountain to force miners to cut back on production, it hasn’t happened. In fact, in the first quarter of the current financial year, Rio Tinto produced 8% more iron ore than in the same period the previous year, setting a new quarterly record of 66.4 million tonnes of the stuff. But at the same time, shipments were up 16% to 66.7 million tonnes. Copper production was up too, by 17%, and we saw production and consumption rising across the board.
3. China is fine
And all that fear of a Chinese slump looks overdone. Sure, the country’s economy is growing faster than we’d like, and the government’s attempts to haul it back below 7.5% have not been having a great effect yet.
A shift more towards private business and away from government schemes might have an adverse effect on China’s domestic production too, but recovering world economies will surely provide a boost to Chinese exports. And over the long term, the giant is not going back to sleep now that it has awoken.