What About the Global Recession?

The recession has greatly impacted commodity prices. Oil has dropped from its record level of more than $147 a barrel in July, to less than $40 a barrel. Analysts are forecasting a near 60% drop in the price of coking coal for next year, as well as price declines of 20% to 30% for aluminum, copper and nickel.

But even with these price declines, BHP’s margins could actually expand in many of its key lines, as marginal players shut off production and BHP’s volumes expand. Cost-cutting, new lower-cost production, and synergies may also offset the adverse effects of falling prices.

Additionally, prices for iron ore and coking coal could actually start to rebound as more governments turn their attention to massive infrastructure projects and the need to diversify energy sources. 

For example, BHP is still moving ahead with an expansion in its uranium production, as the company has “so far been able to substantially maintain sales volumes.”

At the same time, the uncertainties with respect to prices are huge.  Currently, from iron ore, to copper and aluminum, price negotiations for next year’s contracts have gone nowhere.  Buyers insist on bringing contract prices closer to the now-lower spot prices, but producers are trying to minimize the damage by waiting for prices to bounce back.

Until that happens, the old contracted prices – which are much higher than the current spot prices – are still in effect for much of BHP’s volume. Of course they will come down, but the real question is by how much. 

Why Commodities Could Come Back Faster than Wall St. Thinks

Wall Street estimates have are extremely bearish at the moment. That is reflected in BHP’s stock price, which has been slashed by nearly three quarters in the past nine months.

However, I do not believe any of the current price projections are factoring in the two “mothers of all infrastructure-stimulus plans,” being launched simultaneously by China and the United States. The operative word here is stimulus.  And the focus of these plans is infrastructure, which uses huge amounts of steel, copper and other raw materials.

Also, all of these commodities are priced in U.S. dollars.  And the U.S. Federal Reserve just happened to drop the benchmark Federal Funds rate down to nearly 0.00%, while also shifting its monetary printing presses into overdrive. This is likely to lead to an orderly decline of the dollar, and consequently, a rise in commodities prices.

Other countries are in the same boat – from China, India and Australia, to the European Union, and even to Brazil and Chile. In every case, the central banks are dropping interest rates and bank-reserve requirements, and launching stimulus plans along similar lines, even as their central governments are cutting taxes.

Inflation will be a key result.