Global equity markets continued to come under pressure overnight although there was a small relief rally
experienced by energy and resources stocks. This morning the Reserve Bank of New Zealand (RBNZ) decided
to cut the OCR to 2.50% from 2.75%.
At The Minute insights
BHP – Cheap as Chips?
Global equity markets continued to come under pressure overnight although there was a small relief rally
experienced by energy and resources stocks. This morning the Reserve Bank of New Zealand (RBNZ)
decided to cut the OCR to 2.50% from 2.75%. As we pointed out the decision was finely balanced and the
RBNZ cited a recent rise in the NZD, low inflation, and drought risk from El Niño weather patterns as main
factors influencing their decision.
As we mentioned yesterday, while we remain cautious on the resource sector generally, we see value in
shares of mining giant BHP Billiton which was recently added to our Australian model portfolio. Weak
Chinese trade data earlier in the week did not help the fortunes of resource stocks and commodities are
being pummelled into submission. Yesterday iron ore fell to a recent low price decline of almost 70% since the start of 2013 alone. In saying that, we believe BHP shares are now trading far below a fair price (see chart of the moment below) and we are taking this opportunity to buy shares on the basis of a medium term recovery.
The Situation
The Australian “Mining Boom” is clearly over with commodity prices selling off materially over past 2 years and the decline in prices accelerating recently. As such our portfolio contains only one mining stock (BHP), and we are much more positively positioned towards the Agricultural sector as the next big multi-year theme for Australasia.
What’s causing the decline
China Boom is Slowing: China was earmarked as the major driver of global growth over the next 10 years
and was expected to drive commodity demand. It has been growing at an astonishing pace with GDP growth of over 10%. However, recently this has not been the case. GDP growth has moderated to around 7% and there are now fears that the world’s second largest economy could slow further or even crash. believes a crash is unlikely. It can be expected that China’s growth moderates from its blistering 10% growth rate over time and 7% is by no means disappointing when compared to other developed nations.
Excess Supply: The additional supply from new entrants and relaxation in trade restrictions in some key
commodity markets have hampered their performance. For example the removal of trade restrictions on
Iran in July this year has been a major factor in oils slide. Along with the growth in the US shale gas industry, there is a major imbalance between supply and current demand in the oil market.
Global growth: Emerging market growth has been slower than previously anticipated. The slowdown in
global markets has limited the demand side’s ability to absorb the extra supply that has been
introduced. is forecasting a gradually recovery in global growth in 2016/2017. Eventually demand will
meet the current supply, limiting further declines in commodity prices.
Equity Market Implications
Although most companies are net users of commodities and therefore benefit from lower commodity
prices (lower costs), when there are large declines in commodity markets equities tend to be dragged lower
as we have seen this week. However we remain positioned as we would under normal equity market
conditions and do not believe the current market correction will be a broad long lasting sell-off.
Chart of the Moment – Commodity Crash
BHP is now at its lowest price since 2005. We believe the recent sell-off is an overreaction and at current prices we see longer term value. At current levels BHP is offering a yield of circa 10%. While dividends at this level are likely not sustainable longer term, we see this as an indicator that BHP shares are oversold. BHP is our favoured, and only Resources exposure in the Australian portfolio as it is highly diversified by
region and commodity type, and due to its size has scale to operate at low cost
with premium asset quality.
Five Things Markets Will be Watching this Week
1. Whether global markets can follow the US moves on Friday and reverse the sharp sell-off experienced by markets at the end of last week.
2. The Reserve Bank of NZ will make a monetary policy decision on Thursday. While we believe there is likely to be no change to the official cash rate (OCR) this month, and hints of the timing of further rate cuts in 2016 will be looked for.
3. European GDP numbers will be released on Tuesday, and the health of the European economies will be a key factor in determining whether the European Central bank needs to provide further stimulus.
4. The performance of the US dollar this week will be in focus, as to whether it gains strength on the back of a higher likelihood of a hike by the US Fed, in our view.
5. China export and import data is due to be released on Tuesday, and will be watched closely as investors assess the level of slowdown being experienced in China.