A Forecast for BHP from Beyond the Grave

Iron ore mining
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Oh dear. The Sydney Morning Herald reported last week that the December quarter was not kind to the junior miners of Australia.

Eight were delisted, one was suspended, and three entered voluntary administration. Even more are in cash preservation mode, and not even exploring.

Half of those remaining only have enough cash left to fund one, maybe two, more quarters on their current balances.

If investors, or their bankers, don’t pay up, it’s good night nurse for all of them. It could get could get bloody.

But hold that thought! Today we’ll explore whether this could finally mark the bottom for commodities in 2016

Watch how this massive project develops

Don’t laugh just yet.

I know you’ve probably heard the bottom called for commodities more times than you care to remember since their last peak in 2011. Investors who dabbled in the miners have mostly been butchered ever since.

But consider the wider environment. Shareholders are reluctant to fund capital spending on new projects with low prices and the return on investment unappetising.

But as the juniors get wiped out, it kills off new projects. Here’s the rub. The old mines go on producing, but are always depleting.

That’s the kind of thing that can give commodity prices a kick higher as supply drops. It’s been a long five years in commodities. And you don’t bring on a new project in a few months. They take years.

Here’s what we do know. We’re going to know pretty quick how keen the market is for a major capital raising in this space.

Over in the UK, a company called Sirius Minerals wants to raise US$3.5 billion dollars to fund a vast polyhalite mine beneath the North York Moors national park.

According to the Telegraph in the UK, polyhalite is a combination of potash and chemicals such as potassium and sulphur. You probably guessed where this is going already: fertiliser.

Sirius just released its feasibility study. The project is enormous. It’s the largest in the UK since the 1970s. They would need to build a tunnel 36 kilometres long underground. It could be mined for at least 50 years, possibly 100.

The project would be built in two phases over five years. The company says annual profits of between $1bn and $3bn are on the cards once the project is up and running completely.

Here’s the catch. Sirius Minerals only has 25 million pounds in the bank. Just to complete the first phase of the construction it needs to find US$1.63 billion through debt and equity.

It’s not easy to raise that kind of cash for mining plays these days. That’s especially with potash prices trading at around eight year low.

Investors will be sceptical naturally enough that the company can hit its budget. There’s always the risk of costs blowouts in any project, but especially on such a large one.

You only have to look at the Gorgon LNG project in Western Australia to see that.

It was original slated to cost US$37 billion and ship its first gas in 2014. It ended up costing $54 billion, and is only shipping its first gas this week.

But it’s not all bad in the mining industry right now. Certainly lithium and gold stock have done just fine recently.

And last month I saw a small signpost that maybe the worst is over the for the commodity rout…

Analysis from 1923 that may prove true today

It came on 23 February this year, when BHP Billiton [ASX:BHP] announced it was cutting its dividend payout by 75%. It was the first cut since 1988.

Now that’s interesting, isn’t it? The outlook for BHP doesn’t look good. A US$5.6 billion dollar loss, dividends cut, low prices.

Not so fast. Take this from the book Truth of the Stock Tape written by man called WD Gann in 1923. He’s talking about a stock called United Retail…

Insiders knew a long time before the dividend was cut that it was going to be cut, and they were buying the stock. Now, all you had to do was to wait and see if they would give it support around the previous low level…

In many instances when dividends are cut it is the time to buy as the worst is known and has been discounted. As a rule when dividends are increased and extra dividends paid, the insiders are distributing the stock and they bring out good news in order to entice the public into buying…

Let’s take a look at the BHP chart…


Source: STEX

[click to open in new window]

And BHP looks to be behaving just as Gann says in the above quote.

The dividend is passed but the company fails to break the previous low before the dividend is cut. It makes a higher low. That’s actually bullish as far as the chart is concerned.

Certainly, the bad news is priced in now. Old WD knew a thing or two about markets.

Don’t let the mainstream headlines deceive you. To stay ahead of the market, go here.

Regards,

Callum Newman

Ed note: The above article was originally published in Money Morning.

Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.
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