RIO TRADING BUY

Ready to rally?

The bear story in Rio is well known. The super cycle in iron ore is over and is now structurally oversupplied. This will remain so given the low marginal cost of production of the tier 1 suppliers.

As a result everyone is downgrading their commodity estimations making Rio’s marked to market P/E over 20x and seemingly very expensive. However the analysts are late to the party as the commodity downgrades are already in the price.

If the Iron Ore forecasts prevail, the dividend is no longer covered by cash, and the div will either be cut or the balance sheet will be used to protect it. The result is that RIO is now -6% YTD and part of one of the most underweight sectors in the market.

Has iron ore reached a short term bottom? The oversupply is being subtly addressed by BLT who are delaying a 25MT expansion, by VALE who’s output was down to 74.5m tons from 83m tons last quarter, and by RIO who missed production yesterday.

The effect? A 6% move higher in IRON ORE overnight.

The other contributing factor to commodity weakness in general has been the DXY strength. I am not a currency trader but this has lost momentum in the last 2 months which may provide a small underlying bid.

Add to this a 5% yield (for now), a lingering bid rumour from GLEN and a market that is in full unwind mode. Mean reversion or unwind of the extreme underweight market positioning are powerful forces as we have already seen in oil names.

These factors make RIO a compelling TRADING BUY.