Ready to Deliver in Short and Long-Term

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Perhaps no other international mining company in the world is as closely tied to the Chinese economy as Rio Tinto (NYSE: RIO). China is by far Rio’s largest market, representing $8 billion of gross revenues.  Despite record production and sales from Rio’s Pilbara iron ore mines in Western Australia the company has seen revenue and profits decline from a year ago.  Record sales this year from the company’s Pilbara iron ore mines in Western Australia failed to overturn the challenging economic conditions facing Rio.  The fall in copper and aluminum prices are partially to blame.  But the real culprit is the volatile iron ore market.  Iron ore has been on a roller coaster as the following chart shows.  It has now returned to a low not seen since the world began to come out of the Great Recession in 2009.  

<img src="http://static.cdn-seekingalpha.com/uploads/2012/11/2381951_13534271454607_rId5.jpg" />

Other mining companies heavily invested in iron ore have also seen troubles. Xstrata (XTA) was trading near $1284 earlier in the year when iron ore prices appeared to be moving to its pre-Great Recession levels, but they have fallen down to around $950 currently. The downturn in the Chinese economy this year is where these companies are putting the blame. The stock price of BHP Billiton (NYSE: BHP) also tracks fairly closely the price of iron ore, as it has fallen from a high around $82 back in February and now trades under $69. These three mining companies are all heavily exposed to iron ore prices and must see stabilization to return to high growth.

With the debt crisis still looming and making Europe’s economy look moribund, and the fiscal cliff uncertainty still raging in the United States, China and other developing nations are going to be the catalyst that drives up steel demand and in turn sees iron ore price to pre-2009 levels.

In China, targets have been set that seek to double total GDP by 2020.  What this means, at a minimum, is massive infrastructure projects for the country.  This construction increase will be a huge catalyst for steel demand and will drive iron ore prices worldwide.  The Chinese government’s decision to place economic growth front and center is great news for mining companies, and most particularly Rio.  The company has shown an ability to continually increase production, combined with price increases the mining giant will soar to new heights in the upcoming years.  I expect the Chinese economy to be back to double digit growth by the first quarter of 2014, if not the last quarter of 2013.  Further, this growth will continue to pick up more strongly as government stimulus measures recently announced begin to flow to infrastructure investment.  

The short-term looks bright for Rio, but what about the long-term?  I expect steel demand, recent volatility duly noted, to rise for many years to come.  As markets in China, India, and Brazil continue to grow, and populations continue to urbanize there will be need for large scale infrastructure projects for decades to come. With global steel demand certainly on the cusp of an increase investors should view the recent downturn of mining stocks cautiously.  I see real value in Rio, and right now might be the best time to get on board that the market will see.  Rio is a well run company, with a nice record of increased production and project on-time completion.  When you combine this efficiency with demand increases of its most important product, then the value is unmistakable.

One big concern I have going forward is Rio’s cost-cutting program.  We have seen some miners beginning to cut back on production.  Vale (NYSE: VALE) has cut back on iron ore pellet production.  Such a cut is not detrimental given that it should be very easy to ramp production back up.  What is more troubling is the sale of assets.  Vale is under pressure to sell assets and has indicated that it will look to sell-off underperforming assets.  Anaconda Mining (ANX) recently sold some of its iron ore assets to a private Chilean company.  These assets sales would be the wrong approach for Rio.  It appears that Rio is not interested in selling off iron ore assets, looking instead to cut administrative costs by closing some offices and moving others to lower cost locales.  Rio remains bullish on commodity prices in large part because they believe Chinese growth will grow in the coming year.  This is good news for investors.  Now is not the time to panic and sell off assets just before demand shows substantial growth.  Cutting costs without cutting production is the right path to take in the current environment.  

Rio is currently trading around $48 per share. Demand in the developing world is only going to increase in the long term.  In the short-term, we are going to see enormous growth in China, much of it in infrastructure improvement.  Now is the perfect time for investors to get in with Rio Tinto before these infrastructure projects come online.  I predict the stock to see a steady rise through winter and into spring where it will see $60.  As iron ore prices continue to increase and stabilize, Rio’s tremendous production capabilities will make one of the, if not the most, attractive of the mining stocks.  Smart investors will get in while there is still tremendous value to be found.


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