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“Buying on the rumor and selling on the fact” was the initial reaction to news that Rio Tinto (RTP), the world’s second largest base metals miner, earned $3.5 billion in the first half of 2006, or 75% higher from a year earlier. RTP jumped 2% on the Australian Stock Exchange on August 3rd, shortly after the earnings release, but then fell back by 1.2% in London. From a year ago however, RTP is 62% higher at around US$111 per share, after tacking on a 13% gain in the first half of 2006.

Rio Tinto owns stakes in the world’s two largest copper mines in Chile and Indonesia, which generated $2 billion of profit in the first half, while iron ore added $900 million. Copper and iron ore accounted for 78% of Rio's profit. RTP also owns uranium. Higher commodity prices increased earnings by $1.8 billion, offsetting a cost increase of $513 million. Higher energy costs boosted expenses by $56 million.

After hitting a record high of 250 /share, RTP suffered a severe 25% correction from May 11th thru June 13th, to as low as $185 per share, or double the 12.6% setback for the Morgan Stanley World Index during the same four-week period. The correction in RTP was triggered by a 20% slide in the London base metal index, from its all-time high. With the swift recovery of base metal prices since June 13th however, RTP regained its footing over the past six weeks.

RTP is spending $6 billion this year and next to build and expand mines that produce coal, copper and iron ore, as China buys more raw materials to build cars, plants and homes. China accounted for 14% of Rio's first-half sales compared with 13% a year ago. So while RTP looks cheap at just 14.3 times 12-month trailing earnings, its fortunes are also closely tied to the performance of the sizzling China’s economy, which expanded at an 11.3% annual rate in the second quarter.

China’s central bank has drained 420 billion yuan ($52 billion) of liquidity from the banking system over the past six weeks, and raised its 7-year bond yield by a quarter-point to 3 percent. But these tightening steps are minor compared to the 7 trillion yuan of excess liquidity held at Chinese banks. It appears that Beijing wants to prevent its economy from overheating, and is aiming for a 10% growth rate.

Chinese imports of minerals soared exponentially from $1.2 billion in Feb 2002 to a record $10.3 billion in May 2006. Rio Tinto and BHP Billiton (NYSE:BHP), the world’s largest miner, are betting heavily on strong Chinese demand for base metals in the years ahead. As for the price of RTP, much will also depend on how far other central bankers will go in tightening global liquidity with higher interest rates.

The Federal Reserve is winding down its two-year rate hike campaign, following similar decisions by central banks in Canada and Korea. But the powerful Bank of Japan and European Central banks have a little more tweaking to do with baby-step rate hikes. The broader Australian stock market has been weakened by two quarter-point rate hikes by the Reserve Bank of Australia over the past three months.

But there are also indications that Beijing might finally relent to a 3% to 5% upward revaluation of the Chinese yuan, to fend off pressure from a US Congress, threatening 27.5% tariffs on Chinese imports. If correct, a stronger yuan would enhance China’s buying power abroad, a potentially bullish signal for base metals and Australian miners.

As for RTP, only a close above $115 per share would signal further gains to as high $230/share. Otherwise, expect profit-taking on good news.

- Gary Dorsch writes Global Money Trends, an investment newsletter covering global asset markets.

Source: Is it Too Late to Buy Base Metal Miners Rio Tinto and BHP Billiton?