'Commodities Supercycle Is Simply Pausing For Breath'
Published: October 25 2006 03:00 | Last updated: October 25 2006 03:00
The recent strength of base metal prices has confounded the sceptics. Lead, zinc and nickel have all hit record levels while tin has surged to its highest level since 1989. Such gains have defied the forecasts of many investors who believed that the peak in the cycle for metal prices had passed.
US oil prices have declined by a quarter since early August but base metals have largely resisted crude's gravitational influence, displaying unexpected price resilience in the face of a US economic slowdown and concerns about its impact on global demand growth.
Base metals markets remain very tight with available stocks - measured as a percentage of daily global consumption - sinking to rock bottom levels. This is reflected in the spreads between cash prices and the three-month futures prices. Cash prices for all base metals currently command a premium over three-month futures prices, reflecting the extreme tightness of short-term physical supplies.
This means that any news that affects potential supplies is having an immediate and dramatic impact on prices, as illustrated by the surge in tin prices after the Indonesian government closed down 20 small smelters for operating without proper permits.
There are concerns that current price levels are unsustainable as new supply is both inevitable and imminent.
This is reflected in the fact that markets are expecting that over the next four years commodity prices will return to their old long-run averages.
Analysts at Morgan Stanley are forecasting an extended period of high base metals prices with supply unlikely to close the gap with demand growth for five to 10 years.
Endemic supply side problems from skilled labour shortages to the challenging nature of many new deposits are leading to structural cost pressures. Long-run prices will need to be significantly higher to justify developing the marginal new capacity required to balance the market, according to Morgan Stanley.
Demand for base metals looks set to remain robust due to the gigantic infrastructure requirements in emerging markets.
Expansion in galvanised and stainless-steel production has generated huge demand for zinc and nickel.
Jeremy Gray, of Credit Suisse, says: "China's new rail and underground spending programme in the next five years could be bigger than the rest of the world's total investment in the last 20 years."
Credit Suisse adds that India's share of global copper demand is forecast to rise from about4 per cent currently to 10 per cent by 2010.
Wiktor Bielski, of Morgan Stanley, says the "supercycle is just pausing for breath". He adds: "Long-term prices should be 50-100 per cent higher than levels used over the past 10 to 20 years."
This could have significant implications for mining equities. The market's unwillingness to price in an extended period of high metals prices has seen mining shares de-rated.
Citigroup's estimates suggest that UK miners are trading on a 2007 price/earnings ratio of just 8.5 times. Low valuations and the certain prospect of further merger activity in the sector has tempted many hedge funds to set up trades, which offset long exposure on mining equities with short positions on metals prices.
More bearish analysts point to the risk that a global economic slowdown will hit metal prices.
"Slower than expected global economic growth will moderate the pace of demand growth for base metals, which may allow supply to temporarily catch up with demand," says Alison Nathan, of Goldman Sachs. The bank recently cut its forecast for returns from industrial metals over the next 12 months from 10 per cent to 5 per cent. Another problem facing investors in the sector has been the poor returns from the main commodity indices this year (mainly due to falling energy prices). Some analysts think this means it is unlikely the market will see a repeat of the influx of new money from pension funds and other long-term investors that happened at the start of this year.
But if the global economy is in better shape than mining, equity investors predict, the metals markets might not quickly deflate as they think.
The Financial Times Limited 2006 |
