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The past month has been a rollercoaster. The conflict in the Middle East has escalated further, with Israeli attacks on the terrorist organisation Hezbollah in Lebanon and Iran launching almost 200 missiles at Israel.
There have now been at least two assassination attempts on Donald Trump, and the US election in November promises to be explosive and controversial no matter which way the result falls.
We've also seen a massive accommodative pivot from the central banks in the US and China, which are set to light a fire under global markets.
With all this change, it's important to step back, take a deep breath and reevaluate our opportunities. In tough and turbulent times, you can't go too far wrong if you just stick with high quality businesses. And there are plenty to choose from on the ASX.
We've got one in mind that's poised to capitalise on the current economic environment. It's one of Australia's favourite companies and one of the highest-quality management teams on the ASX.
Before we discuss this iconic Aussie stock, we need to set the scene. We'll discuss the current forces in play and our thesis of why this stock could benefit.
The Inflation Dilemma
Inflation is a beast of a thing, but it takes time to be fully felt. In recent years we've seen boom in inflation fuelled by supply chain disruptions, rising transportation costs, energy costs and a housing shortage.
Inflation has started to stabilise and we now have to adjust to the new normal of higher priced goods and services.
But that's not all.
Inflation has not been applied equally. The following chart shows the rapid increase in CPI in Australia in orange. As long as the CPI line is above zero, prices are higher than they were a year prior. So, there's a cumulative effect that makes the surge in prices much more dramatic than what is depicted here.
| | Source: Shares in Value / ABS
The blue line shows wage price inflation. It hasn't kept up with the prices of consumer goods at all. So on average our wages now buy far less stuff than they did in 2020.
Dramatically so.
And that's why the cost of living is going to be a key battleground in the looming 2024 Australian election. A lot of households are noticing a tightening in the their living standards.
This nicely shows how abrupt changes like we've seen can dislodge the healthy balances that we're used to. There is now a lot of pressure for wages to shuffle themselves northwards to catch up with the price of goods.
Here's the thing, though. When that happens, it will cause a fresh surge in inflation, as goods and services need to be increased in price to account for rising costs.
This is what makes inflation such a tough beast to tame when it gets out of control.
But there are even more reasons coming for consumer prices to increase.
Interest Rate cuts will spur further spending
That's interest rate cuts.
We've already seen them hit the USA and China, where interest rates have been cut by 50 basis points. These two countries alone account for about 44% of global GDP. So, when they both kick into rate cutting mode in a big way at the same time you can be sure the markets will feel it.
Australia could see a cut as early as December, and it's fully priced into the bond markets by February 2025. Additionally, the expected magnitude of the cutting cycle has increased dramatically in recent months.
Interest rates are expected to fall more than 100 basis points in the next twelve months, which will spur further spending.
The impact of inflation being still strong, upward pressure on wages and massive stimulus kicking off from the two biggest economies in the world could lead to much bigger CPI numbers to come in the next few years.
The Commodity Play
Commodities, in general, tend to respond well to inflation pressures. That's because they typically work on a cost plus nominal margin pricing equilibrium. If prices go way above the cost to mine something, then every dog and his human goes looking for that precious resource, finds a few deposits and then brings them to commercialisation.
Supply increases and prices subsequently fall.
Once prices fall below cost, the most expensive operations begin to close, one at a time. Supply decreases, and prices increase. This happens around an equilibrium price, which is the price at which supply would theoretically stay stable.
Of course, it never quite reaches that magic equilibrium in practice.
This price plus nominal margin pricing mechanism in commodities makes them the perfect hedge for inflation over the medium to long term.
While gold is the obvious choice, many other commodities work as well.
There's a major blue chip stock hiding in plain sight on the ASX right now that looks to be perfectly positioned to take advantage of the coming price escalations if they play out the way we envisage they might.
It's a household name, and you may well have it in your portfolio. We are talking about the biggest company on the ASX right now, BHP (ASX: BHP).
There are many reasons to like BHP. It's a high quality business with great leadership. You could say they are experts and acquiring and optimising the lowest cost of production assets that are most exposed to growth demand applications, while simultaneously getting great value for divestments of non-core assets.
BHP is a big company with a lot of moving parts. But we are going to focus in on four commodities in particular for this article and how they could influence the next 1-2 years of BHP's financial results and how the stock performs.
Iron
Iron is currently the most important commodity in the portfolio. It keeps the lights on.
In FY24, BHP produced 259.7 Mt of iron ore. World-class unit cash costs of US18.19/t are expected to fall further to US$17.50/t over the medium term.
Studies are underway to increase production to 330 Mt as well. So there's potential for both margin and volume increases. On the pricing front we've seen a spike up recently following China's stimulus for the housing market.
If this price turnaround can get some legs and continue further north it could mean a massive boost to the bottom line over the next few years. Of course that's heavily dependant on the China construction story turning around as well.
But this early move is very positive and should be watched closely.
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Source: TradingView
Copper
FY24 production of copper was 1,865.2 kt. The company owns a stake in the biggest copper mine in the world – Escondida. Various initiatives are underway to increase production and efficiency at the Chilean copper operations.
A strategy is in place to double the copper production from South Australian copper operations to 650 ktpa. This comes on the back of BHP increasing copper production by 292 ktpa between FY22 and FY24.
Current copper mineral resources stand at 44 Bt at 0.59% copper. Given our own bullish outlook on copper this is great reason in itself to be getting into BHP.
After copper's big pullback from the highs of May, we've seen another run-up in the last few weeks, driven by the stimulus measures out of China and the US.
With copper becoming harder to find, grades decreasing and the massive growth implied in the electrification story, copper exposure is a must for the next decade. What better than owning a piece of the worlds biggest copper mine?
| | Source: TradingView
Nickel
Didn't BHP shut down it's Nickel operations? You are right reader, they sure did. So there can't be a positive here can there?
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Source: TradingView
Well, the good news is that the price of Nickel has caught a bid, you guessed it, since the US and China decided to cut rates. It's too early to pop the champagne, but it's a good sign, and has certainly caught out attention. BHP has resolved to review it's Nickel assets in 2027, so we don't expect them to flip the switch on restarting production anytime soon.
However, this could be a nice bonus in a few years time if it gets switched back on again. Of course we'll need to see robust Nickel prices become the new norm before then. Recently the price has been capped by cheaper production out of Indonesia.
Potash
BHP has a mammoth Potash project in the works called Jansen. Stage 1 is running ahead of schedule and is over 50% complete.
BHP always tries to own the lowest cost and highest quality assets in growth commodities. That's how the company manages to continue making money when it's competitors are forced out during tough times.
Well, the Jansen Potash project is no exception. It requires around 60% less equipment than its competitors. That's a big deal, given the high capex and maintenance costs of mining operations. As a result, Jansen is expected to sit at the low end of the potash cost curve.
One of the best hedges against inflation is food, and one of the most universal ingredients to food is fertiliser. That's where potash comes in. While there are some other uses, it's primarily used to supply potassium as a nutrition source to crops.
Potash prices rocketed in 2022 due to disruptions from covid and the war in Ukraine. While prices have since discovered gravity and are now back to more reasonable prices, it highlights how critical potash is to the global food industry.
Jansen promises to give BHP one of the best assets in the industry and exposure to the critical food supply chain.
Final Thoughts
BHP is a high quality operation that deserves a look even at the worst of times. Right now we are seeing some positive signs re-emerge for this mammoth enterprise. Commodity prices have already started to turn, and strong inflation drivers for the foreseeable future could underpin great revenue growth for years to come.
Commodities are always the plaything of central banks and inflation, and this time is certainly not looking any different. So we like a basic and dependable commodity play as part of a balanced portfolio to ride out this current macro economic and political hurricane we're currently in.
While the share price has recovered somewhat in recent weeks, BHP (ASX: BHP) is far from fully priced. The consensus FY25 forward PE of 12.8X is an attractive proposition for such a solid performer. The trailing 12-month dividend yield of 4.95% also becomes more attractive as interest rates fall.
If you're worried about the prospect of lingering inflation and the flow on effects, check out BHP as a potential medium term play.
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