Why I've Bought Rio Tinto

LONDON -- Trying to predict the future is a mug's game, but despite this, I'm pretty certain that the global economy will still need large amounts of iron ore and copper in several decades' time.

That's one of the reasons why I recently added shares in Rio Tinto (ISE: RIO.L) to my retirement portfolio. This is a company I tipped back in June as a great buying opportunity and which currently offers a dividend yield of 3% -- below the FTSE 100 average, but quite respectable for a miner.

Income focus
As I've written before, the investment philosophy behind my retirement portfolio is based on balanced, long-term investment in the main sectors of the global economy. Barring a global economic meltdown, I hope that this approach will provide a decent dividend income for me when I eventually retire.

Why Rio?
Of course, Rio isn't the only big miner in the FTSE 100. The most obvious alternative is BHP Billiton (ISE: BLT.L) , another Australian-based diversified miner with a more than 40 billion pound market capitalization and a big business in iron ore.

I don't pretend to have the expertise necessary to independently value each of these businesses and forecast their earnings, but I do know what I want, and I chose Rio for three main reasons:

  1. It's cheaper. Rio currently trades on a price-to-earnings ratio of 6.0, compared to 9.6 for BHP Billiton. Over the long term, I expect this discount to even out.

  2. Copper: Rio is in the final stages of opening a large new copper mine in Mongolia. This is expected to contribute to a 13% annual rise in earnings from the red metal between now and 2015. I see copper as a good diversifier to help reduce Rio's dependence on iron ore, from which it currently gets around 80% of its earnings.

  3. 23% of BHP's earnings came from its petroleum business in 2012. As I already own shares in Royal Dutch Shell, I didn't want any more oil exposure.

An alternative idea
Given my goal of gaining an income stream from the global commodities market, I did identify another attractive possibility that you might want to consider.

If it succeeds, the proposed merger between Xstrata (ISE: XTA.L) and Glencore International (ISE: GLEN.L) will create the biggest mining and commodities company in the FTSE 100. "Glenstrata" would have a market value of 53 billion pounds and could be an attractive long-term investment, as both companies are currently valued quite modestly.

Although mergers are always a risk, Glencore already owns 20% of Xstrata, and the two companies look like they should be a good fit. The uncertainty over the deal has driven down the share prices of both companies over the last month, and Glencore's shares are down by more than 8% -- so now could be a good time to buy, as the price could rebound once the uncertainty abates.

Not my choice
The FTSE's mining sector is home to five companies with market values greater than 20 billion pounds. Of these, the only one I haven't mentioned so far is Anglo American (ISE: AAL.L) , whose share price has dropped by more than 23% so far this year, making it by far the worst performer of the five.

Many of Anglo's operations are in South Africa, and this is causing problems at the moment. Anglo American Platinum sacked 12,000 miners (20% of the workforce) at its Rustenburg platinum mine on Friday, following their refusal to return to work after an illegal strike or attend disciplinary hearings.

The company's Kumba iron ore mine is also being affected by strike action and falling commodity prices have hit Anglo hard this year. However, you could argue that much of the bad news has already been factored into the company's share price, making it a possible contrarian buy.

Mining a recovery?
Mining shares tend to be quite volatile and are extremely cyclical. The last thing you want to do is to buy these shares at the top of a cycle, when yields are low and prices are high.

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In the report, the Fool's expert analysts explain why they expect these two mining shares to deliver strong returns -- and identify two alternative high-quality shares that provide an excellent opportunity to capture ongoing growth and income.

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The article Why I've Bought Rio Tinto originally appeared on Fool.com.

Roland Head owns shares in Royal Dutch Shell and Rio Tinto, but does not own any of the other shares mentioned in this article. The Motley Fool has a disclosure policy.
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