BHP, Australia’s largest resource company, last week should have put to bed hopes of a quick return to the boom times. But, for the moment investors are refusing to lie down.

Producing what can only described as a cautious third-quarter trading update, BHP emphasised the slump in world demand was weighing heavily on its prospects.

As it flagged production cuts across the myriad of commodities it produces, it said: “In the medium term we expect that market conditions will remain uncertain … all our operations remain under review. We continue to take actions in any business that is cash negative and set to remain so, or where there is a lack of demand.”

This outlook stands in sharp contrast to the previous quarter’s commentary when BHP referred to stronger long-term fundamentals.

The forces it is facing are most apparent in its iron ore business, which generates around a third of its profits, and is suffering a slump in demand in line with a collapse in the world steel market.

During the last quarter BHP sold as much as 47% of its iron ore production into spot markets, where prices are as much as 40% lower than the long-term contract price it struck this time last year.

The move, which reflects steel maker requests to defer iron ore deliveries based on contract prices, compares to its typical practice of selling between 10% and 20% into the spot market.

Although production slipped 4% on the second quarter it was still ahead of the same period last year.

Its petroleum division, the next largest in terms of contribution to total profit, produced around 3% less than during the same period last year.

Admittedly, this partly reflects cyclone damage in its Gulf of Mexico operations and the depletion of its Stybarrow operations in Western Australia, but the division will still have to weather a slump in oil prices from $US147 last July to a low of $US30 in December. Add to this a worrying supply situation.

Oil inventories are already some 300 million barrels above normal and are still rising. Such unprecedented surpluses could take a year or more to work off, especially in times of such anaemic economic prospects.

Production of metallurgical coal, which generates around 13% of BHP’s profit and is the firm’s third largest profit centre was, down sharply on the previous quarter, but still ahead of the same period last year.

Of the other products it produces, only zinc, uranium and diamonds remained ahead of the previous quarter.

And then there are specific problems such as the troubles at its massive Escondida copper mine in Chile, where problems at a grinding mill and lower grade ores means full-year production will be down 30% on last year.

There is of course plenty for the optimists to grasp.

BHP exported more iron ore and more metallurgical coal than it did in the same period last year. This is in stark relief to the US GDP figures this week, which showed a quarter on quarter contraction in excess of 6%.

The company has in short, demonstrated an extraordinary ability to manage a downturn.

Meanwhile, its capacity to weather spot market prices and its determination to continue to run its assets hard has the effect of pushing those producers lacking BHP’s balance sheet closer to the wall. Margins, meanwhile, remain well ahead of where they have stood in previous downturns.

Finally, BHP’s balance sheet is a major cause of envy for its competitors. Its net debt represents just 15 % of its equity and although this ratio should deteriorate over the coming year to reach 21%, it stands in sharp contrast to its chief rival Rio Tinto’s 72% debt to equity ratio. BHP is in a very strong position to bolster its already formidable portfolio of projects at a time when its competitors are reeling.

But it is not clear if these factors are sufficient to warrant its current share market rating. BHP is now trading at around 19 times next year’s earnings, this compares with a forecast price earnings ratio at the height of the boom in 2007 of around 12 and its historical average of around 14.6 times forecast earnings.

Ironically, however, this high price that could play into its hands as it would find it relatively easy to sell to investors issuing new shares to fund takeovers.

Faced with expectations of economic recovery, investors apparently find it hard to contain their enthusiasm.

BHP is held in as much esteem in Australia, as Fonterra is held on this side of the Tasman.

Richard Inder is an investment adviser at Macquarie Private Wealth. His disclosure statement is free and is available on request. Clients may hold shares in the firms mentioned. Comments, think differently? Write to richard.inder@macquarie.com