The BHP Billiton Limited (ASX: BHP) share price started 2017 like a bull out of a gate. Within the first month, it had amassed a gain of more than 11% – compared to the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) which remained flat during the same period. This left many investors questioning whether they too should back the rampaging BHP share price for another stellar year.
Since then, BHP's share price has gone backwards. In fact, it has completely reversed those early gains: one share is fetching $25.06, the same price BHP's shares closed at on the final trading day of 2016.
The question investors should ask is whether this is an opportunity for investors to buy? Or should it be taken as a sign to steer clear of the rampaging bull?
Should you buy BHP Billiton shares?
The BHP share price collapsed to a low of $14.06 in January 2016 as commodity prices tanked. BHP's resurgence since that time has taken many in the market – myself included – by complete surprise. It has been driven by a strong rebound in the prices of commodities such as iron ore, copper and oil.
As a producer of those commodities, BHP is a clear beneficiary of stronger commodity prices. Particularly when the miner itself has spent much of the last few years focused on stripping out unnecessary costs from its business to maximise returns from those operations.
There is no doubting that investors who have held the shares from the bottom (at around $14 per share) to now have benefited greatly. But investing is not about past returns. It's about estimating future returns, and ensuring you pay a reasonable price today based on those expectations of cash generation and profits.
The iron ore price has fallen sharply over the past few sessions, with one tonne of the resource now fetching US$90.50, according to data from The Metal Bulletin. Many within the industry, including Fortescue Metals Group Limited's (ASX: FMG) own CEO Nev Power, have at times questioned the fundamentals supporting the iron ore price's rally, with indications it could struggle to maintain its current price tag in the medium-to-long run.
All that is to say that BHP's share price rally has been strongly supported – and even driven – by surging commodity prices. But if commodity prices start to fall consistently, then BHP's share price could also fall just as quickly. Indeed, it has already fallen more than 6% in the past three sessions!
Foolish takeaway
While some investors might see BHP's recent share price decline to be an opportunity to buy, I would think twice before doing so. Before you make a move, consider first what will likely need to happen to see its share price rise higher (for example commodity prices rise further) and compare it to the possibility of how much the shares could decline if commodity prices were to drop from here.
If you think the possibility of commodity declines outweighs the possibility of further gains, then it may be more suitable to look elsewhere for other investment opportunities.
