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The Risks Of Investing In Rio Tinto Plc

Today I am highlighting what you need to know before investing in Rio Tinto (LSE: RIO) (NYSE: RIO.US).

Weak iron ore prices to dent revenues

On the face of it, Rio Tinto put in yet another stellar performance during the first six months of 2014. The business saw iron ore production gallop 10% higher during January-June, to 139.5 million tonnes and which marked a fresh half-year production record. On top of this, the mining giant also saw shipments surge by a fifth to 142.4 million tonnes, also a new six-month peak.

However, many commentators believe that iron ore sales could experience a sharp deceleration very soon as steel mill restocking comes to an end. And on a longer-term basis, fears abound that floods of new material from the world’s major producers could swamp the market.

Against this backdrop, just this month Bank of America-Merrill Lynch decided to slash its iron ore forecasts for this year and next. The Rio Tintoproduction prospects of commodities leviathan China continues to dominate sentiment, and the bank expects that “Chinese mines will be around for longer, as government incentives, lower than expected costs and access to higher-grade areas provide support”.

The institution now expects the steelmaking ingredient to average $107 per tonne this year on a cost, insurance and freight basis, down 3% from its previous projection of $110.

The bank was even stricter on its guidance for 2015, with a new forecast of $95 per tonne marking a 10% downgrade from its former estimate of $105. And Bank of America expects the material to remain at these price levels until the end of 2018 at least.

Given that buckets of new capacity are also set to hit the market from Australia and Brazil over the next couple of years, exacerbating the already-worrying fundamental imbalance, Rio Tinto could be in for a prolonged period of earnings weakness — the business sources in excess of 75% of total earnings from the iron ore market.

On top of this, oversupply in many of Rio Tinto’s other key commodity markets is also likely to weigh on the firm’s revenues outlook for the next 24 months. Indeed, Bank of America has also cut its forecasts for copper, uranium, molybdenum, and hard coking and thermal coal through to the end of 2015, with only aluminium bucking the trend. These issues could have a disastrous effect on the company’s bottom line in coming years.

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Royston Wild has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned.