The new China Syndrome: Commodity price boom sets alarm bells ringing
Mining firms cash in but policymakers increasingly worried over inflationary threat
By Philip Thornton, Economics Correspondent
25 February 2004
There is a major economic boom gripping the world - an asset price bubble perhaps - but few people in the UK will have noticed. Prices of a vast range of commodities, from cement through coal to copper, have surged over the past year and the root cause is another C-word - China.
The world's most populous country is sucking in the world's raw materials at an unprecedented rate to feed its domestic economic boom. It imported 30 per cent more oil last year than in 2003, making it the world's second largest importer after the United States. It accounts for half of the world's consumption of cement, a third of its coal and more than a third of its steel, according to Barclays Capital.
While the demand for raw materials has surged, the supply capacity has been unable to respond at the same pace and prices have surged as stock levels have tumbled.
Prices for metals are red-hot. Copper prices have raced to eight-year highs as part of a broad-based surge that saw a jump in the prices of tin, zinc, aluminium and lead - all of which are heavily used in manufacturing.
The price spike may have had commodities dealers and traders in mining stocks jumping with joy, but it has set alarm bells ringing at central banks worried about having to control inflation once the incipient boom takes hold.
Certainly there are some clear winners. Shares in the world's largest mining companies have ballooned over the past year. Shares in Xstrata, the London-listed Swiss miner, have doubled, BHP Billiton has jumped more than 50 per cent while Rio Tinto has risen 15 per cent. Antofagasta, the only pure copper producer listed in London, has seen its share price double over the past 12 months to take it to the brink of entry into the FTSE 100 index.
"Steel industry demand, global demand for finished products, are flying," said Tom Cutler, an analyst with Clarksons shipbrokers in London, citing booming demand in China, South Korea, Japan and Europe. "I've even heard that Teesside has begun exporting iron ore to China."
Shipping owners and brokers have cashed in, with a record rise in sea freight costs. JE Hyde, the 100-year-old shipping broker, this week described the market as "extraordinary", calling it "a freight market so strong the like of which has never been seen before".
This has raised the cost of chartering a ship and securing a port berth, as well as adding to business costs thanks to the extra delays.
Tim Bond, author of Barclays Capital's annual report into asset prices, its Gilt-Equity Study, said the boom had sent prices up "vigorously". "It's not just commodity prices but transportation prices as well," he said. "Marine shipping prices have mostly tripled and in some instances if you want to charter a ship immediately it has quintupled over the last couple of years."
The two big questions for the financial markets and policymakers are how long the price spike will last and whether it will trigger a surge in inflation.
Mick Davis, the chief executive of Xstrata, the mining company that announced a fall in profits yesterday, said there was a "huge amount of speculation" over the market in 2004.
"Across almost all the base metals, prices have been driven upwards by a combination of demand for product, particularly in the Far East and associated with China, and tightness in supply," he said.
"While we see little evidence that the demand side of the equation will change for the worse - in fact there are encouraging signs that it is continuing to increase on the back of returning growth in the Western economies and continuing strength of the Chinese economy, the outlook for increased supply varies between the different commodities."
Deutsche Bank agreed, saying it was forecasting further rises in commodities prices. "We are quite bullish because of the dollar weakness and also because of the global reflation cycle," said Amanda Lee, an economist in its commodities research unit.
"We think that demand will increase, while for the past few years the infrastructure spending and exploration to discover new metals sources had been frozen, so new supply may not be able to support the increasing demand, especially from China."
John Meyer, a mining analyst at Numis stockbrokers, said previous prices spikes in 1972, 1978 and 1985 showed that an initial rise was followed by a brief period of consolidation before embarking on a further rise.
"It's my view that metals prices will take a second leg up and that there are further opportunities for investors to buy into mining stocks in anticipation of an equity bull run," he said. He pointed to anecdotal evidence of supply shortages in minor metals such as cobalt, cadmium, nickel and chromium.
According to Barclays' Tim Bond: "This is probably the longest and broadest-based commodities rally we have seen since the 1970s."
Mention the 1970s and commodities in the same sentence and anyone with a long memory or a sense of economic history will recall the huge spike in the oil price.
There is a vigorous debate among economists over the impact of a rise in commodities, and particularly oil, on inflation and growth. One camp says the vast technological innovation over the past three decades has left the industrialised world far less vulnerable to a commodity price shock.
However others say the West is still dependent on consumption of fuel and raw materials, and point out that every recession - including the one that began in 2001 - can be blamed on an oil price spike.
David Bloom, global economist at HSBC, said that in fact rising commodity prices were, perversely, part of disinflation or falling prices. "The traditional idea of increased demand leading to increased commodity prices and then goods prices and finally wage demand doesn't hold," he said.
Commodities made up only a fifth of the cost for Chinese companies making finished goods, with the bulk of the rest going on wage costs. "China has low unit labour costs so they are making goods cheaply, the prices of finished goods is falling and this is encouraging more demand," he said. "We are talking about a billion people in China making cheap goods."
Others are not so sanguine. Mr Bond said there was a consensus that the issue was more for profit margins than for headline inflation. "Our view is perhaps a bit different in that the scale of the rises we are having in raw materials prices and the fact that they are so widespread, means they are probably going to be an issue for output prices."
Douglas McWilliams, the chief executive of the Centre for Economic and Business Research, agreed with Mr Bloom that an initial benefit from cheaper goods prices would be superseded by price pressures as the global recovery took hold.
"Our model shows that the impact is a timing one," he said. "The commodity prices pressures will come through when economies are reaching the limits of capacity.
"Central bankers will anticipate and move interest rates accordingly, and particularly in the US we believe that super-low interest rates will disappear quite fast."
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