is bhp cheap? some thoughts and charts

As I mentioned before there was in the past a maxim that resource stocks should be bought on high PEs and sold on low. This is a comment on long term price cycles, not meant to be applied to short term trading. Resource stocks tend to peak at the time they are making record profits due to sky high commodity prices. The market rarely factors this into its share price fully as there will be doubt over the sustainability of those prices, so the PE will be lower near a top.

The current "stronger for longer" cycle has complicated this, especially as it was interrupted by the GFC. So the chart isn't perfect but you can see a general trend is evident.



The direction of BHPs share price is better dictated by commodity prices, particularly copper:



This doesn't make a lot of sense, because copper is only a small part of BHP's commodity mix. On the other hand it is a useful proxy for sentiment towards China, and the outlook for growth there.

There is also a decent correlation with iron ore prices:



This also doesn't entirely make sense from a fundamental viewpoint either. Iron ore certainly forms a larger component of their profits, but it overlooks the increasing volumes they are shipping. It also appears that it may be BHP that is the leading indicator for the IO price, not vice versa.

What concerns me about the long term chart is the large head and shoulders forming. It hasn't broken down yet so its not something to panic about right now. On the other hand if it can add another dollar or two from here the pattern won't look so menacing.



You don't have to be a China bear to think that the supply side of the commodity equation might eventually catch up with them. By 2020 they plan to double iron ore production, so do RIO. FMG will triple their output by next year, Vale is also expanding, new operations are starting up. if supply tightness doesn't persist, then the marginal cost may drop on even a slight slackening of demand growth. If they end up shipping 400mt at $100/tonne they will be worse off than shipping 200mt at $150/tonne as those extra tonnes will come at higher cost. But if they don't, then competitors will take their market share, smaller operations in particular have nothing to lose and everything to gain by ramping up production aggressively.

So its hard to see this as a good long term story unless there is a fresh upswing in commodity prices. This is not the scenario they are themselves suggesting, instead talking about expanding volumes. There may be opportunities to catch it when its been sold down too heavily, but quite likely the top is already in. Since dividend yield, and the speculative upside is limited its understandable the market prices it at such a low multiple.