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Buying Rio Tinto shares could be the ultimate contrarian investment

A senior group of friends enjoying rowing on the River Derwent
A senior group of friends enjoying rowing on the River Derwent

Rio Tinto (LSE: RIO) shares have struggled to keep pace with the broader market recovery that has followed the pandemic lows of March 2020. This appears entirely logical. Rio Tinto is a mining company that provides commodities critical to economic expansion, such as major infrastructure projects. Given the headlines are dominated by talk of recession and persistent inflation, it does indeed seem to be a stock for me to avoid.

However, I think that by focussing on just two global indicators, I might be able to invest in this stock at a very favourable price while everyone else remains defensive.

Firstly, it’s all about the dollar

To remark that the present economic environment is confusing for investors would be an understatement. But there is one asset that has performed consistently, and that is the US dollar. Its rise has been relentless. Commodities are priced globally in dollars, so as the dollar rises, the price of those commodities drops. By extension, this impacts profits at Rio Tinto

Additionally, a strong US dollar is detrimental to those many countries that hold their debt in dollars. This means a larger proportion of their capital expenditure is spent on debt repayments rather than building projects. Hence large-scale demand for commodities remains soft.

Therefore, my working assumption is that if the dollar’s trend starts to show signs of a reversal, this would be beneficial to Rio Tinto.

And secondly, China

No country has absorbed more raw materials than China. Its inexorable growth has been breath-taking. But that all came to a halt during the pandemic and China’s uncompromising zero-Covid policy.

China is the world’s largest importer of iron ore, which makes up two-thirds of Rio Tinto’s operations.

In other words, all I need to do is to monitor any future weakness in the dollar and look for encouraging signs that China is building again. A combination of these two factors should, in theory, provide a significant boost to the Rio Tinto share price.

So when to buy?

In the past week the US Federal Reserve has hinted that interest rate rises may start to slow. This has already allowed some currencies to appreciate against the US dollar. Then over the weekend we hear reports out of China that Covid restrictions may be relaxed and steps will be taken to re-open the economy.

None of these factors are by any means a certainty. But I do believe that monitoring both Federal Reserve and China policy could prove advantageous.  Buying shares in Rio Tinto could then indeed provide me with a head-start on any economic recovery.

And if I buy the shares too early? With a respectable present dividend yield of 11.5%, that will certainly help me ride out any drawdown.

The post Buying Rio Tinto shares could be the ultimate contrarian investment appeared first on The Motley Fool UK.

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Michael Hawkins 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.

Motley Fool UK 2022