I have been worrying about the outlook for mining giants BHP Billiton (LSE: BLT) (NYSE: BBL.US) and Rio Tinto (LSE: RIO) (NYSE: RIO.US) for some time, and it looks like I was right to be concerned.
Markets were so busy applauding their record production numbers that they wilfully overlooked the danger posed by falling demand, but now it’s impossible to ignore.
As the global economy stutters, Chinese growth slows, and commodity prices plunge, their share prices have inevitably followed. Rio is 18% off its 52-week high, while BHP is down 21%.
Is this just the beginning, or a great buying opportunity?
Heavy Metals
The scale of the collapse in commodity prices, led by oil, came as a shock even to me. The iron ore price is down 44% this year, on slowing Chinese steel-making.
The copper price is down 7% in the last three months.
There seems little chance of a quick rebound, with latest Chinese data showed factory growth dipping in October, while investment growth fell to a 13-year low.
Even the Japanese QE bonanza has done little to reverse the slide.
Copper Hits Bottom
With Europe slipping into self-induced senility, and China stumbling into the middle income trap, the global economy will continue to struggle.
But there are some signs of hope, if you look for them. Copper, often seen as a global economic barometer, is showing signs of stabilising, which suggests better news to come.
Cheaper oil could also fire global activity.
At a company level, BHP and Rio have the size and scale to withstand falling prices, unlike many of their smaller rivals, some of whom could be driven out of business.
Ramping up production helps in this respect, by cutting their output costs, allowing them to maintain healthy margins even at a lower price.
When the global economy turns, last man standing wins.
An Either/Ore Trade
Trading at 10.4 and 8.6 times earnings respectively, their valuations are certainly tempting. As are their dividends, with BHP yielding 4.63% and Rio on 4%.
If you’re feeling unfashionably bullish, the mining sector could lead the recovery. I fear their share prices could soften further, however, especially after reading Citigroup’s prediction that the iron ore higher price will drop to under $60 a tonne next year, from today’s £75.
Things could get worse for BHP Billiton and Rio Tinto. But as time passes, and the commodity cycle swings round, the investment case will get better and better.
