Fade Coronavirus With BHP Group - A Scale-Down Opportunity In The Commodity Giant

Summary

• Risk-off hits commodity prices.
• China is ground zero for the virus.
• China is the demand side of the fundamental equation.
• BHP is a diversified producer.
• The dividend is high, and the shares are near the 52-week lows - a scale-down buying opportunity for the long term.
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The risk-off conditions over the spread of the coronavirus around the world are hitting the global supply chain like a ton of bricks. Commodities are global assets, so a worldwide recession can wreak havoc with prices. Commodities can be a highly volatile asset class. Raw material prices can double, triple, or halve in value based on changes in the macro supply chain, or the individual supply and demand factors for each market. This week, the price of crude oil plunged to its lowest level since 2016, as OPEC could not agree on a production cut to address falling demand on the back of the spread of the virus around the world. The Saudis decided to flood the market with oil as Russia refused to cooperate with a reduction in output.

Supply and demand factors in commodity markets can cause sudden and violent price moves, but the population growth is a factor that underpins prices. At the turn of this century, six billion people inhabited the earth. Two decades later, the number has risen by 27.3% to 7.635 billion. More people, with increasing wealth in the world, means that the competition for finite raw materials is growing. BHP Group (BBL) is a diversified producer of a host of natural resources. The Australian company is a world leader in the commodities business.

Risk-off hits commodity prices

Falling interest rates and a weaker dollar in the United States are typically bullish factors for commodities prices. The dollar is the world's reserve currency and the benchmark pricing instrument for most raw materials. A decline in the value of the US currency tends to be highly supportive of commodity prices as strength in other foreign exchange vehicles often leads to increased demand at lower costs in other currencies.

Source: CQG

The chart of the nearby dollar index futures contract highlights the recent decline from a new high of 99.815 in mid-February to 94.61 on March 9, a drop of 5.2% over the past three weeks. The falling dollar is typically bullish for commodity prices.

Source: CQG

The chart of the 30-Year US Treasury bond shows the massive move to the upside that took the long bond to a record high of 193-06 this week. The yield on the ten-year Treasury fell to an all-time low of around 0.50% on March 9. Lower rates reduce the cost of carrying inventories and long positions in commodities and should be a supportive factor for raw material prices.

Meanwhile, the reasons for a weaker dollar and runaway bond prices are working against commodity prices. The decline in the dollar index is at least partially because of an unwind of the dollar versus the euro cash and carry trade caused by risk-off conditions. Falling interest rates are a response to panic in markets over coronavirus and a flight to quality.

Three of the benchmark industrial commodities have declined over the recent weeks despite the moves in the dollar and rates.

Source: CQG

The sharp decline in crude oil prices to the lowest price since February 2016 was the result of a perfect bearish storm. The failure of OPEC to address the decline in demand with further output cuts that launched an output war pushed the price of nearby NYMEX crude oil futures to a low of $27.34 at the start of this week. The futures contract was around the $34 per barrel level on Monday after bouncing from the low.

Source: CQG

The price of copper and other base metals fell on the back of risk-off conditions. The red metal fell from $2.6250 per pound on the nearby COMEX futures contract on March 3 to just above the $2.45 level on March 9 before bouncing to just over $2.50.

Source: CQG

Meanwhile, the daily chart of lumber futures shows the drop from $477.70 on February 20 to $356.70 at the end of last week. Lumber is one of the most interest-rate-sensitive commodities, but the current environment has pushed the price to the lowest level in 2020.

Risk-off has hit all asset classes causing the prices of stocks, commodities, emerging markets, and rates to fall significantly.

China is ground zero for the virus

The outbreak of coronavirus began in January in China. Efforts to quarantine millions of Chinese exposed to the virus have not stopped it from spreading to other countries around the world across all continents.

China is the world's most populous nation, with almost one and one-half billion people. Moreover, the Asian country is the demand side of the equation for commodities and a leading manufacturer of goods that flow around the world. With economic activity in China grinding to a halt over the recent weeks, the rest of the world is not only feeling the impact of coronavirus with rising cases, but the economic effect has rippled around the globe like a tsunami.

China is the demand side of the fundamental equation

Commodity prices rose to all-time highs in 2011 when the Chinese economy was still experiencing double-digit economic growth. In late 2015 and early 2016, when economic expansion in China slowed, commodity prices fell to multi-year lows. Lumber reached a low of $214.40 per 1,000 board feet in September 2015, copper reached a bottom of $1.9355 per pound in January 2016, and crude oil fell to its nadir of $26.05 per barrel in February 2016. When it comes to the global economy, when China catches an economic cold, the rest of the world comes down with financial flu. Since the world's most populous nation is ground zero for the virus, the spread beyond its borders has caused a period of panic in markets across all asset classes. Commodity prices are now falling, and the potential for more selling will rise with the number of cases around the globe.

BHP is a diversified producer

Coronavirus is dangerous, but so far, the mortality rate is somewhere around 3%. The segment of the population that is most vulnerable are the elderly and those with chronic conditions. Meanwhile, influenza claims many victims each year. In the US alone, the flu accounts for 60,000-100,000 fatalities each year. Since healthy and younger people that contract coronavirus likely suffer cold-like symptoms, the number of cases is likely much higher than current reports. Therefore, the mortality rate from the virus is probably far lower on a percentage basis.

Scientists and governments around the globe have mobilized in the quest for a vaccine and treatments to minimize the impact of the virus. Based on past outbreaks of SARS, MERS, Ebola, and other threatening conditions, treatments will likely be available sooner rather than later, saving the lives of even those most vulnerable to the virus.

The risk-off behavior in markets could reach a peak over the coming days and weeks if that has not already occurred. While markets can fall a lot further, it is a good time for investors to consider a plan to take advantage of those assets that are falling to bargain-basement prices.

BHP Group has a market cap of just over $74 billion at a share price of $29.39 per share on Monday, March 9. The stock trades an average of over 1.4 million shares each day. The company operates through its petroleum, copper, iron ore, and coat segments. It explores, develops and produces oil and gas and mines copper, silver, zinc, molybdenum, uranium, gold, iron ore, and metallurgical and energy coal. It also produces, smelts, and refines nickel. The Australian company sits in a favorable geographical location close to the world's leading consumer of raw materials, China.

The dividend is high, and the shares are near the 52-week lows - a scale-down buying opportunity for the long term

Over the past 52 weeks, BBL shares have traded between $28.99 and $51.87 per share. The stock was trading at a price to earnings multiple of 7.92 at $29.41 on March 9. At the current share price, BBL pays shareholders an over 8% dividend. The yield could be in jeopardy in the case of a prolonged period of weakness in demand for raw materials.

Meanwhile, in the world of commodity production around the globe, BHP is a leader. The odds that the company will survive a prolonged slowdown in the global economy are high. Moreover, BHP's diverse assets put the company in a position to thrive when the demand for raw materials expands in the future.

Source: Barchart

The chart shows that at the height of the commodity bull market in 2011, BBL shares reached a peak of $86.96. In early 2016, when prices fell to multi-year lows, the shares reached a bottom at $16.36. At around $29.40 on March 9, the stock is at the lowest level since mid-2017.

The over 8% dividend is attractive but could decline or disappear if commodity prices continue to slide. However, the potential for long-term capital growth in one of the world's leading commodity-producing companies makes the stock a scale-down buy from its current level. It is impossible to guess how long the current risk-off environment will last or how low prices can sink before they find a bottom as they did in 2008 and 2015/2016. Volatile commodity prices tend to drop further than most analysts believe possible during bear markets and rise far above target levels during bull markets. I would be a buyer of BBP shares on a scale-down basis in the current environment, leaving plenty of room to add to a long position on further price weakness.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.