One of the best investments an Australian investor could have made over the last 10 years would have been to buy a large chunk of BHP Billiton (ASX: BHP) stocks. This is simply because BHP shares have outperformed gold, listed or unlisted property and most ASX listed blue chip stocks I can think of. But have BHP shares now rallied too far and what does it’s share price tell us about the demand for commodities?
When I look at the chart of the BHP stock price the first question that comes to mind is: what is driving the stock price back up towards multi-year highs?
Although it could be getting a nudge upwards by a combination of factors including the possibility some entity will try and buy a strategic stake in the company, the main driver behind BHP’s share price rally appears to be the Chinese “miracle” economy.
BHP Billiton versus ASX All Ordinaries 4 Year Chart
The chart above highlights a number of aspects regarding how the global financial crisis unfolded in Australia over the last few years.
Firstly we can see how Australian stocks (ASX) hit bull market highs in the last part of 2007 and how the BHP share price also hit an all time high around this period as well.
Then at the end of 2007 stocks began to fall, after that there was a true “sucker’s rally” from around March 2008 before stocks went off a cliff after Lehman Brothers collapsed in September.
As you can see BHP shares did tumble fairly much in sync with the overall market but it’s share price held up better than the overall ASX All Ords Index.
This is because the demand for commodities was supported by China’s apparently insatiable appetite for iron ore and coal etc. In addition, government’s around the world started to spend in order to support their economies and as a result this also helped put a floor under commodities volumes and prices.
These factors are largely what saved Australia from recession. If China and the other G-20 nations did not go on a spending spree, Australian would have slipped into more than one quarter of GDP contraction last year.
I know most Australians like to believe that the nation escaped a recession because our economy is so well tuned or managed but the reality is we were lucky. If the nation had significant export focused manufacturing sector we would have felt much more economic pain. We simply avoided a recession because our economy lacks diversity.
The problem I see at the moment is that BHP has now soared well ahead of the ASX All Ords Index in terms of performance over the last few years and this worries me little.
BHP Billiton versus ASX All Ordinaries 20 Year Chart
The 20 year chart above highlights how the BHP stock price started to race ahead of the All Ords from late 2003 as the commodities boom kicked in. It is also fairly clear that it is now soaring even further ahead and even despite the drop in it’s share price yesterday, (and maybe even again today) it is still heading up towards another all-time high.
But just because a stock is outperforming the ASX All Ords does not mean it is overpriced or has rallied too far, so let’s compare the BHP share price to another Index that it was in the past closely aligned with: the AMEX Oil & Gas Index.
BHP Billiton versus AMEX Oil & Gas Index (XOI) 10 Year Chart
As you can see from this chat the close correlation between the BHP stock price and the AMEX Oil & Gas Index basically fell apart when the global financial crisis took hold in 2007-2008. There is still a correlation between the two, but the BHP share price over the last few years has clearly had a better run than oil and gas.
What the BHP share price suggests to me is that investors are buying into BHP and other mining/resource related stocks because they are convinced that the Chinese economy will keep growing at a rapid pace.
If the Chinese economy slows (and I am not talking about a crash) then this will spook investors and stocks like BHP I suggest, will tumble. Therefore I am more inclined to be a seller of stocks like BHP at this time rather than a buyer.
My guess is that the Chinese economy will come off the boil either this year or next and that we will see commodities prices and related stocks undergo a correction.
But as usual my timing is likely to be poor, so my own course of action will be to sell some holdings in mining related stocks when they rally and look to pick some up if and when, a correction hits the sector. I won’t try and get the precise timing right, but hopefully I will ride the longer term trend correctly.
Please remember that all of the above is my personal view and is not intended to act as any form of investment advice.