Why Buying BHP is Like Swimming Upstream

The ongoing crash in commodity prices wasn’t enough to force the Reserve Bank into an ’emergency’ rate cut yesterday. But the prospect of another rate cut in Australia is much nearer than most people think.

Earlier this week, manufacturing data out of China hit a two year reduced. Monday night, a studying of US manufacturing came in less strong than expected. This wasn’t great news for the commodities sector. Copper and gold lost about 0.5%. Brent crude fell a massive 5% to just above its January 2015 low point.

The item rout is now a bloodbath. As the Financial Times reviews:

‘The commodity rout is now officially as bad as during the financial crisis. The actual Thomson Reuters Core Commodity Index, the actual broadest and longest running basket of tradeable oil, whole grains, and metals, just fell to a level last seen in February 2009.

‘The drop in the index comes as Brent crude oil offers dropped back below $50 the barrel for the first time since The month of january and as copper and aluminum prices fall to a six-year reduced.

‘The TR CRB index hit 199.7688 around lunch break in New York, down from 203.1 on Friday. It’s low in early 2009 in the peak of the financial crisis was 199.6386.‘

By the end of the day’s trading, the index closed below this year’s low. The commodities boom is well and genuinely over folks. Keep in mind although that this is a US dollar denominated index. The situation is not quite as bad when you look at things through the lens of a weaker Aussie dollar, as you can see in the graph below:

In Aussie dollar conditions, commodities hit a low point back in 2012. Falling fossil fuel and iron ore prices (not reflected in the above chart) led the RBA to aggressively slash interest rates throughout 2012.

Commodity prices rebounded strongly into 2014 thanks in part to a depreciating Foreign dollar. Then came the oil price rout, which sent the index back down to test to June 2012 lows.

So far the lows are holding, but the chart certainly doesn’t look healthy. If you were to include the economically important fossil fuel and iron ore prices in to the above chart, then Australia would indeed be looking at the actual worst commodity price levels seen in many years.

Despite this, the RBA did not pull out a surprise cut the other day. I wrote in the past’s Daily Reckoning that I didn’t think he would, but one is coming at some point.

Bank boss Glenn Stevens may want to wait another month or two to see whether attempts to cool the housing percolate have had any effect. Rates of interest on investor loans have increased across the board, but so far it is had little effect.

By just about all accounts, capital is still pouring into Aussie property. A 25 basis point improve for investors is hardly enough to reduce interest in the sector. A weaker Aussie dollar is playing it’s part too. For foreign investors, a weaker Foreign dollar increases their buying power.

The Financial Review reported yesterday the Cromwell Property Trust [ASX:CMW] has had a deal from a Korean asset administration fund for its Cromwell Box Slope Trust. The trust is the owner of an Australian Tax Business building currently under construction in Box Hill in Melbourne.

And just last week, the Chinese sovereign wealth fund China Investment Corporation (CIC) bought Investa Property Group’s nine workplace towers for a massive $2.Forty five billion, placing the assets on a very low (bubble such as) yield of 5%.

As the Financial Review documented at the time:

‘The more than 30 per cent slide by the?Australian buck and the record low interest price environment?helped drive up the cost but also made it?more compelling for?offshore investors transacting in US dollars.’

In short, funds continues to flow into Sydney, buying up prime assets. How are lower rates of interest going to help? They won’t. Just about all they will do is encourage more speculation in residential property and more consumption on the back again of speculative gains.

To financial this borrowing and consumption binge, we need foreign capital, and we’re getting it by selling off our best property.

Pretty smart, huh?

The more property we sell, the more future income generated by those assets flows offshore. This will show up in the years ahead using a continually growing current accounts deficit.

The only potential gold lining is that you could make a disagreement that Chinese buyers aren’t particularly astute. Over the past couple of years, Chinese investors haven’t covered themselves in glory.

There would be a lot of buying of commodities near the top of the cycle in 2011, there is the Chinese property bubble, a gold buying spree as prices run up in 2011, and much more recently capital chasing speculative returns in the Chinese stock exchange.

In short, Chinese capital loves momentum, which is why you’re right now seeing big investments within Aussie property. Could the recent record investment from CIC symbolize another market peak?

Not in the event that rates and the dollar keep falling. Australia’s broken economic model still has some life inside it yet.

Getting back to commodities, are you looking to buy, with prices striking multi-year lows?

While the typical contrarian response will be a ‘yes’, I would say no. Why try and pick the bottom? Why not wait for signs that the downtrend has finally run its course prior to loading up?

Let’s use BHP for example. This is how I go about picking stocks picks (or avoiding them) in my Sound Money. Seem Investments newsletter.

The chart below shows the two-year performance of BHP. We recommended BHP as a ‘short sell’ in September last year. That means you make cash on the trade when the cost falls.

I knew BHP would are afflicted by falling iron ore prices and at the time the oil price had started to fall dramatically too. More importantly though, the stock price had just made a new low as well as was entering a downward trend.

The combination of negative basic principles and a charting outlook that confirmed the negative view was enough for me to tell subscribers to sell.

Now, as you can see through the downward sloping green arrow, the downtrend is well established. While BHP may be attempting to bottom right now, the path of least resistance is unequivocally down.

The odds favour this particular downtrend continuing, and I wouldn’t be shocked to see BHP break through support at $25 and make new lows in the weeks or months ahead.

I’ve discovered from painful experience that purchasing in the face of a downtrend is like swimming against a current. It’s tough work and there is a low probability of achievement.

You’re far better off waiting for the actual downtrend to exhaust itself and for a new turnaround to emerge before getting involved.

So if you’re tempted to buy commodities at this point, go jump in a river and try swimming upstream. Then, lay lying on your back and let the current get you. How much easier is that?

If you have in mind investing using this approach of blending fundamental and specialized analysis, click here. As you will see, it works.

Regards,

Greg Canavan,
Editor, Sound Money. Seem Investments

From the Port Phillip Publishing Library

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