Here’s why the BHP Billiton share price has sunk 14%

It was a little over a week ago that shares of BHP Billiton Limited (ASX: BHP) hit $19.44.

Investors behind the ‘Big Australian’ were over the moon as they watched their shares soar to their highest price since late November, marking a 38.3% gain since bottoming out at just $14.06 in January.

Fast forward to today however, and it seems reality is starting to kick in again. The shares have retreated 2.6% so far for the session and are trading 14.2% below that high achieved on Monday last week at $16.68.

Indeed, shareholders of BHP Billiton have endured a rough trot in recent years. As a by-product of the wind-down of the mining boom, commodity prices have plunged with BHP’s two most important commodities – being iron ore and oil – hit particularly hard.

Although both resources have rebounded strongly in recent weeks, giving investors in the sector a reason to become hopeful again, they have once again resumed their decline. Iron ore, for instance, has fallen over six-straight sessions, including 4.8% overnight to US$52.88 a tonne, according to The Metal Bulletin, while oil prices have also retreated below US$40 a barrel again. Brent oil was down 2.6% overnight.

While the rally was enough to excite investors, it seems they are now realising that much of the gains were pinned on hope rather than any solid evidence to support a long-term rebound, with supply of both commodities still far outweighing demand growth.

Although BHP Billiton is a big producer of both iron ore and oil, it is still a price taker meaning it has no control over the prices it can sell them for. If the recent price gains are reversed over the coming weeks or months (which is entirely possible), hopes for stronger earnings from BHP will continue to fade which could weigh further on its share price as well.

Notably, BHP’s share price has already endured a sharp decline; it’s down almost 40% over the last 12 months and 60% over the last five years. As such, the risk vs reward trade-off has improved, but that doesn’t eliminate the possibility of them falling even further (indeed, one analyst even suggested they could be worth just $6.30 earlier in the year).

As such, your decision to buy or to avoid shares of BHP Billiton should largely depend on your views of where commodity prices are headed – not tomorrow or next week, but in the long run. The same goes for BHP’s rivals such as Fortescue Metals Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO) which have also fallen heavily over the last week.

Although there is potential for solid gains if commodity prices do rise, there is also plenty at stake if they don’t.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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