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Is it time to sell the Big Australian?

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Iron ore stocks such as BHP were drawn into an intriguing story when we learnt on Friday that some of China’s biggest steel mills have called for an investigation into why the price of iron ore has spiked to unexpected levels. And not surprisingly, BHP’s and Rio’s share price copped it on Wall Street and in London over our weekend.

BHP is a stock that a lot of us hold and I have to admit I do have a big holding in my portfolio ever since I started pondering on my TV programme — SWITZER — if it was a good idea to buy the miner in 2016 when its share price was in the low $14 region. I didn’t have the courage of my convictions until it was in the $15 area but that’s my investing way, where I wait for clues that my assessment of a beaten-up, quality company is agreed to by the market. And then I buy.

That said, BHP isn’t my typical company as it’s not a renowned dividend payer but it has beaten its poor dividend history in recent years, which has been a nice happenstance for me. However, I know I have to lighten off with the company, to buy better dividend payers, especially as I migrate my self-managed superannuation fund (SMSF) portfolio to a more defensive income stance, in case a black swan event comes along to negatively affect my still positive view for stocks.

In a nutshell, I expect an eventual Trump trade deal to help the stock market go up another level. But then I’d expect profit-taking to take the market down before a slower grind higher, interrupted by US electioneering and the run of economic data over 2020.

I expect an economic comeback after the trade deal is struck and there could be another surge if Donald Trump wins the US poll in November next year. This could easily produce another well-known Santa Claus rally but then I’d worry that 2021 could be the market’s biggest chance to really sell off. The first two years of a US presidency are the worst for stocks. By 2021, this bull market would have been up for close on 13 years.

So that’s my best guess, if we can rule out a black swan event that could be linked to an escalated Chinese trade war, a real war in the Middle East (starring Iran and the USA), an economic disaster linked to Brexit and the EU. These are all low order worries and I guess you can’t rule out a financial system problem linked to the level of debt, historically low interest rates and the spread of silly populist politicians and the willingness of even sillier voters to embrace them.

Interestingly, our election showed the more conservative voter tendency could be re-emerging and even in Greece with a looming election, the Syriza Party looks set to be tipped out of power for the New Democracy Party, headed up by a Harvard graduate son of a former Greek PM. His name is Kyriakos Mitsotakis and his likely election win says the Greeks have had enough of left-wing promising political leaders with rockstar, leather jacket wearing Treasurers.

But that’s an aside. The swing to more conservative and economically responsible governments might help the global economic recovery rather than threaten it, which is important for BHP and its share price.

Let’s start with what the analysts are thinking about the stock, whose share price has been helped by the tragedy and fallout problems of the dam collapse in Brazil that affected Vale’s supply of iron ore. It explains why BHP’s, Rio’s and Fortescue’s share price has surged lately.

BHP one-year price performance

Source: nabtrade

As you can see, the current share price is $41.29 (at the time of writing) and when the news about the dam collapse broke, it was January 2019 and BHP’s share price was around $33.

Then in May, Vale warned of possibly another dam could collapse and BHP’s share price was then close to $37. It has been a beneficiary of the woes for its big Brazilian rival, so it’s no surprise that the forecasted earnings trend is still positive but these are only best guesses and you can see the rise is tailing off, so it’s right that many investors are wondering if it’s time to lighten off or dump the stock. The answer to these questions depends on how you invest but I will address this later.

Analysts’ Forecasts – BHP earnings for FY19 and FY20

Source: AFR

If you want the professionals’ view, FNArena’s survey of analysts says the target price is $39.03, which implies a 5.5% downside. That’s small. While these specialists are worth noting before making a buy or sell decision, they’re not always right. It’s their best guess and you can bet they’ve done a lot of homework before sticking out their neck and risking their reputation — but they’re only human.

They can’t know exactly what Vale will do over the next few months. They can’t accurately second guess Donald Trump and his trade war plans — who can? They don’t know what will happen with Brexit, the EU and global economic growth, with the latter pretty important to commodity prices.

This is the World Bank’s view for global growth: “Global growth in 2019 is expected to slow to 2.6 percent, reflecting weaker-than-expected trade and investment at the start of the year. Growth is projected to gradually rise to 2.8 percent by 2021, predicated on continued benign global financing conditions and a modest recovery in emerging market and developing economies (EMDEs).”

And here’s their view for non-energy commodities, which iron ore fits into. “Non-energy prices in 2019 are expected to remain below 2018 averages, before rising moderately in 2020 as the global economy emerges from its recent soft patch.”

In May, the view about iron ore prices going forward looked very rosy. RBC Capital Markets described the price increases over the past five months as “exceptional” and the Canadian bank lifted its iron ore forecast by 24% to US$82/mt.

This came as Goldman Sachs was surprised about China’s consumption, while Vale’s production has surprised to the downside. Taking into account China’s crude steel production, Goldman lifted its iron ore price forecast by 12% to US$91/mt! But as spglobal.com noted: “Goldman Sachs and RBC both noted that the iron ore market is probably at its peak in terms of supply tightness.”

Joining the price prediction party was CBA, which lifted its 2019 price forecast by 7% to US$92/mt.

National Australia Bank’s price guess has been bumped up about 5% to US$86/mt, and here’s its thinking: “There remains some uncertainty around the resumption of Brazilian supply — with Vale suggesting that around half of the shuttered capacity could resume within a year, while some would be offline for two to three years,” NAB said.

Clearly, the experts think that Vale solving its troubles and lower Chinese demand aren’t going to knock out iron ore prices soon. But to me, both what Vale does and what China is up to relies on a lot of guesswork!

I don’t expect a big surge or drop in iron ore prices from here any time soon and it’s worth noting what the World Bank said about emerging markets and developing economies (or EMDE). “EMDE growth remains constrained by subdued investment. Risks are firmly on the downside, in part reflecting the possibility of a further escalation of trade tensions. It is urgent for EMDEs to reinforce policy buffers and to implement reforms that boost growth prospects.”

This underlines how critical the trade war will be for the EMDEs, global growth and demand for iron ore but now we have a Chinese inquiry that is a curve ball many wouldn’t have expected.

Despite this, the AFR over the weekend gave BHP shareholders hope with the following: “In a Friday report, London’s Liberum Capital said it retained its forecast that iron ore prices would hold near US$110 a tonne in the second half of this year, ‘with risks to the upside’!” And this mob “reiterated buy recommendations on Rio, Anglo American, BHP and Ferrexpo.”

The nervous investors could reduce their exposure but I’m planning to hold, waiting for a trade deal-related rise in share price. I could reduce my holding, hopefully before a big fall in price, as I want to increase my exposure to dividend-paying stocks.

In a perfect world, I’ll get out before BHP slips and after SWTZ (my dividend growth fund) drops off current highs. That could be easier said than done so I might have to sell BHP in coming months at a high and then wait for a general market sell off to get more SWTZ at a lower price.

However, for the moment, I’m a BHP stayer. But as I’ve said, I will reduce my exposure when a trade deal takes the market up another level because my gains have been too good to lose.

This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531). This article was first published on Switzer Report on 8 July 2019. This material is intended to provide general advice only. It has been prepared without having regarded to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of nabtrade.