A lot of traders and investors will no doubt be contemplating the question of whether BHP is cheap at current levels. Whatever, the medium term prospects, it's hit an interesting chart level this morning that could make it a stock to watch in coming days

Long term risks remain whatever happens with next week's result

The market is heading into BHP's results announcement next Tuesday with consensus expecting a 43% decline in underlying earnings per share to $US 1.43. A further drop of 35% to $US 0.93 is expected in F16.

Of course lower commodity prices are the key driver of declining earnings. BHP's recent production report noted the following averaged realized prices for major commodities in F15

  • Oil down 33% to $US 68
  • LNG down 21% to $US 11.65
  • Copper down 14% to $US 2.78
  • Iron Ore down 41% to $US 61
  • Hard coking coal down 20% to $US 105
  • Thermal coal down 22% to $US 58

Prices, especially for oil and copper have generally continued to trend lower and are well below average levels for last financial year.

Market reaction to next week’s profit result will be influenced by BHP’s cost control and capital expenditure budget. However, looking past the things within BHP’s control, the outlook for commodity prices remains the key longer term determinant of its share price.

Theoretically mining stocks are about the long term valuation of their reserves. In practice, share prices are heavily influenced by the profit outlook for coming months or the next year or two. So your view on whether BHP is cheap now is largely going to be about the difficult commodity question of how weak for how long. The reason this question is difficult, is that history shows that while ever commodities remain over supplied, prices are likely to keep falling. Furthermore, supply responses tend to be slower than everyone expects.

From a tactical point of view, I think there are two potential triggers for coming to the view that BHP is close to a long term low. The first would be for the share price to fall to a level that looks relatively safe even if commodity prices fall considerably more than currently expected. Conservatively, my own view is that this price is below $20.

The second trigger would be tangible evidence that industry wide production cuts are finally happening, especially in oil and iron ore. Waiting for tangible evidence is likely to mean missing the bottom, the market will no doubt begin to pre-empt this. However, it will also mean reduced risk of getting in too early.

BHP chart review

In the meantime, BHP's chart is showing some typical signs of potential basing behaviour as it heads into next week’s profit announcement. This suggests the market is primed for a bullish reaction to anything short of really disappointing news from BHP. Such a reaction may not mean the long term bottom for BHP but could set up for a corrective rally.

The BHP chart looks a chance of completing a “3 drives to a low pattern”. This is a classic basing pattern that would be completed by price making a third low somewhat below the second drive down. This third low  would be a bounce out of the Fibonacci projections around $24.30. These project that the third drive will be the same size as the second and also 1.27 times the size of the last corrective rally. As usual it might pay to allow a little bit of tolerance on either side of this projection zone.

This pattern is a close cousin of the triple bottom. It tells a story of declining downward momentum with buyers consistently finding value a little below the recent support zone. It’s then a case of third time lucky. The last drive down exhausts the sellers and a significant rally follows.

Price has hit the top of the Fibonacci zone this morning. A trend change with a low around this zone in the next couple of days would complete the pattern. A quick move to fill the gap created by this morning's open would be another good sign. This would make it look like an exhaustion gap. This happened with the last correction which moved quickly to fill the gap in the 2nd drive lower.

A third low is required however. If price just keeps falling well through these supports without a bounce, the pattern is negated.

BHP 20 August 15