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Why the Rio Tinto share price is outperforming with the sector today

Brendon Lau
Race

Many of the big ASX miners are outperforming the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index this morning after the price of iron ore hit a five-year high.

The Platts Iron Ore Index, or IODEX, jumped to $US110.20 a tonne and has gained more than 50% since January, according to the Australian Financial Review.

This pushed the Rio Tinto Limited (ASX: RIO) share price up nearly 2% to $103.82 this morning, while the BHP Group Ltd (ASX: BHP) share price added 1.1% to $40 and the Fortescue Metals Group Limited (ASX: FMG) share price surged 4.6% to $8.73.

Iron ore in a seller’s market

Worries about the supply of mainstream iron ore fines are reported to be behind the latest price surge and traders are expecting tight supply in July and August. It’s a seller’s market – at least in the short-term with some analysts predicting the price of the commodity could jump to US$120 a tonne by August.

The strength of the steel making ingredient is defying the gloom cast over the Chinese economy from the ongoing trade spat between the US and China.

This is largely based on two factors. The Chinese government may step up infrastructure construction to offset the slowing economy and that means greater demand for steel.

The other factor is that profit margins for Chinese steel mills are still reasonably healthy. These mills will keep buying iron ore to produce steel as long as they can make a buck!

Risk of a price correction in the second half

But not everyone is a bull. Some analysts, including those from Citigroup, point out that profit margins of these mills are under pressure and have become razor thin in recent times and that the supply of residential property is outstripping demand, which leads to a real risk that steel production could fall in the second half of this calendar year.

This isn’t a given so it’s probably a little premature to be selling off all your holdings in iron ore stocks. The high price of the commodity also gives me some comfort as it provides room for a fall without necessarily triggering a consensus profit downgrade cycle for these stocks.

Foolish takeaway

Many analysts have assumed an iron ore price that’s materially under US$100 a tonne, so even if the ore price were to fall 20% from its expected peak, that shouldn’t impact much, if at all, on share valuations.

On the flipside, if iron ore prices stay higher for longer (and it seems to have a bit of a history of remaining stubbornly high) or if it only dips modestly, shares in our major iron ore producers can enjoy a consensus profit upgrade instead.

But iron ore stocks aren’t the only group with a promising outlook. The experts at the Motley Fool have uncovered some gems that are well placed to outperform in 2019.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. Follow him on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019