The share price of big mining company Rio Tinto (LSE: RIO) has fallen by just over 30% during the past six months.
And at 4,450p, it’s now about 3% lower than it was a year ago. So, the stock went up during the year, only to come crashing back down again.
Booming commodity prices
Yet many commodity prices have been shooting higher recently. So, what’s going on? And is the plunging stock offering me the opportunity to buy some of the shares of this FTSE 100 company at a lower valuation?
Much of Rio Tinto’s trading outcome depends on the prevailing prices of the commodities it sells. And although it might feel like all commodity prices have been shooting up, some haven’t. Oil, natural gas, and aluminium have been hitting the headlines because of their prices surging higher this year. But platinum and silver are flat so far in 2021. And the price of iron ore has fallen off a cliff.
And I reckon it’s the plunging iron ore price that’s hurting Rio Tinto. Although the company deals in several commodities, around 60% of its revenue in 2020 came from iron ore. But the price of iron is around 60% lower now than it was at the beginning of 2021.
Iron ore is used for making steel. And according to news reported by Mining Technology, the tumbling iron ore price coincides with China’s recent actions aimed at reducing the polluting activity of its coal-fired steel mills. The measures imposed by Beijing involve cuts in steel production in the country.
And reducing demand from China could be a big problem for Rio Tinto. After all, in 2020, the company derived around 58% of its overall revenue from China.
I could take a contrarian view
But volatile commodity prices are always a big factor to consider when it comes to investing in mining businesses. And commodity prices tend to cycle up and down according to changes in demand. So, we often see commodities responding to general economic conditions, such as booms and recessions.
I could invest in Rio Tinto by taking a contrarian view with regard to the price of iron ore. However, I’m also worried that other commodity prices could dip lower in the months ahead. And if that happens, it could offset any revenue gains from a recovering iron ore price. For example, the company also generates revenue supplying aluminium, copper, diamonds, and minerals.
At the end of July, chief executive Jakob Stausholm said stimulus from governments because of the pandemic has driven strong demand. And that came during a period of constrained supply “resulting in a significant spike in most prices”. And his use of the word ‘spike’ suggests to me there’s potential for commodity prices to fall again soon.
Of course, I could be wrong and Rio Tinto’s revenue and stock price could recover and go on to hit new highs. But, for me, the situation is unclear with much of the company’s trading outcome beyond the control of the directors. So, I’m avoiding the shares for the time being.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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