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The Pain Isn’t Over Yet For BHP Billiton plc And Rio Tinto plc

There is a general feeling that the worst is over for BHP Billiton plc (LSE: BLT) (NYSE: BBL.US) Rio Tinto (LSE: RIO) (NYSE: RIO.US), as commodity price falls bottom out.

BHP is up 5% in the last month, while Rio is up more than 8%.

Many investors will be tempted to hop on board, before a full-blown recovery is under way. At today’s prices, I have some sympathy with that go get ‘em attitude.

Trading at 1,571p, BHP is 25% off its 52-week high of 2,102p. And at 2,972p, Rio is down 15% from its year-high of 3,530p.

So if this is a sector that you want more exposure to, today’s discounted valuations could make a promising entry point. Just don’t expect a sudden rebound from here.

China Cracks

The main reason for the shake-out are the troubles afflicting BHP and Rio’s biggest consumer, China. Its economy is growing at the slowest pace for six years, with year-on-year GDP growth up 7% in the first quarter of 2015. Many economists reckon the real figure is lower than that. They prefer to follow power output instead, and that fell 3.7% in the year to March.

The other concern is that what growth there is has only been sustained by stimulus from an increasingly desperate government. As elsewhere, this has done more to drive up asset prices than to fuel real economic activity. Industrial output and real estate investment have both fallen to their lowest levels for at least six years. And the IMF expects growth to continue slowing.

Naturally, that spells bad news for BHP Billiton and Rio Tinto.

And although QE appears to be driving a eurozone resurgence, disappointing growth figures in the US and UK suggest the global economy isn’t about to spring back into life. A further rise in the dollar would also hit demand. 

Iron Men

Copper may have found a floor for now but iron ore continues to fall, down from $140 a tonne to around $54 over the last year. BHP and Rio’s policy of maintaining production, presumably in the hope of driving out smaller rivals continues, and it appears to be having some success, with Australian producer Atlas Iron recently suspending output.

But even the big two are pulling back, with BHP recently postponing its iron ore project in Port Hedland, and Rio deferring its Silvergrass mine until next year.

Have they also seen the writing on the wall?

Pain And Gain

The most compelling reason to buy both these stocks now are the yields, currently 4.65% and 4.13% respectively.

The valuations both look attractive as well, with BHP and Rio trading at just over nine times earnings. So the temptation is obvious. But you should still brace yourself for more pain before the outlook starts to brighten.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.