Could mining shares be about to nosedive?

Gold bullion on a chart

The attraction of owning shares in mining companies for many people is the dividends on offer. Over the past couple of years, leading names like Rio Tinto have had yields far ahead of the FTSE 100 average. Could the glory days of double-digit yields and buoyant valuations on some mining shares be about to end, though?

Dividend cuts

Rio announced yesterday that it was cutting its interim dividend by 52%. Today it was the turn of rival Anglo American, which announced a reduction of 27% in its interim dividend.

In fairness, that could still leave plenty of income potential for the shares. Rio, for example, has a historical dividend yield of 11.9%. So even if the 52% cut is also applied to the final payout, the forward-looking yield would be 5.7%. That is less attractive than Rio investors have been used to, but still substantial.

The issue I see is that these dividend cuts may simply be the start. There could be more dividend cuts or cancellations to come from mining shares in coming years. Rio’s has already nosedived. I expect others to follow the industry giant. Mining is cyclical, so when selling prices fall but companies are still lumbered with the high fixed costs of mining, profits can collapse.

Mining shares could fall

But if I owned mining shares, it would not just be the dividend that concerned me right now. I would be alarmed by the potential for share price falls too.

The Rio Tinto share price has actually moved up 3% in the past five days, although it has fallen 21% over the past 12 months. That makes it seem like investors shrugged off the dividend cut that had clearly already been on the cards.

However, if metal and commodities prices keep falling, I expect mining shares could tumble. Between May 2008 and the end of that year, Rio saw its share price collapse 75%. When mining cycles turn, the impact on shares can be brutal. Fittingly enough, I think this week’s dividend cuts could be the canary in the mine.

Playing the long game

I have been following the mining sector and think some UK-based mining businesses have attractive characteristics. But the reason I have not bought any mining shares in recent years is because I was concerned about overpaying. As metal prices soared, so did dividends – and share prices followed.

For now at least, I think we are still a long way off the bottom of the mining cycle. So prices could get much worse in coming years, leading to dividend cuts and collapsing share prices.

That might not happen, of course. It is possible that an uptick in metal demand see profits recover and dividend yields stay high. I think it is unlikely, though. I will be watching mining shares in coming years to spot any signs that prices have bottomed out and could be on their way up again. At that point I would hope share price valuations to be more attractive than they are now. That could be a good long-term investing opportunity for my portfolio. For now, I am steering well clear.

The post Could mining shares be about to nosedive? appeared first on The Motley Fool UK.

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Christopher Ruane 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.