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A peak may be in sight for commodity prices
Jul 28th 2012 | from the print edition
ASSIGNING analysts to cover the humdrum world of commodities and mining was
once investment banking s punishment for low-flyers or copybookblotters. Then
China s pulsating economy and appetite for raw materials sent the prices of
industrial metals and bulk commodities soaring. It turned watching the dismal
world of copper, zinc and nickel, and the mining firms that dug them up, from a
role tantamount to constructive dismissal to glamour.
Can it last? Signs that China s economy is coming off the boil recent figures
put annual growth in the second quarter at a mere 7.6% compared with the
double-digit rates of the past few years have led some to suggest the commodity
boom is over and prices are likely to crumble. That prognosis looks premature.
The past decade has been a remarkable one for metals and bulk commodities iron
ore and coal. Consumers, desperate to get their hands on raw materials, paid
well over the cost of production as demand outstripped supply, which was
constrained by years of underinvestment by mining firms. Many analysts talked
of a supercycle , a long-term surge in prices lasting for decades on the back
of Chinese demand.
Chinese urbanisation has been the fundamental force behind that demand. Until
the start of the millenium China, the world s biggest producer of many
commodities, was largely self-sufficient or even a modest exporter. Economic
reforms have turned it into a manufacturing and exporting behemoth, and have
prompted a vast movement of people away from the countryside to the cavernous
factories and sprawling megacities of the new China. The housing, roads,
railways and infrastructure supporting this shift required massive imports of
minerals.
China s steel production grew by 16% a year between 2000 and 2011. Around half
the world s steelmaking raw materials and two-fifths of its copper and
aluminium now disappear down the dragon s maw. The price of copper, which had
fallen by 0.8% a year in the 1980s and 1990s to reach little more than $1,300 a
tonne a decade ago, exceeded $10,000 a tonne in early 2011 and still stands at
around $7,500.
A slowdown in China has led people to wonder whether the supercycle is over.
The evidence suggests that it has reached a peak. Academics probing supercycles
over the past 150 years reckon that the expansionary phase lasts between 15 and
20 years. Most analysts put the start of the most recent cycle around 2000 (see
chart 1). HSBC, which thinks this cycle is just seven years old, concedes it
faces the onset of creaking middle age and that a long senescence might
follow. Ruchir Sharma of Morgan Stanley sees in a 200-year history of commodity
prices a repeated trend of two decades of price declines followed by one decade
of gains.
Commodity bulls and the world s big mining companies have an answer to all
this. They reckon that China still has far to go in building the cities,
motorways and airports it needs. Marius Kloppers, the boss of BHP Billiton, the
world s biggest miner, points out that 200m Chinese swapped village for city
between 2000 and 2010; he expects another 250m to follow over the next 15
years.
Copper-bottomed boom
Even the bulls accept that demand for copper and steel tends to level off in
the later stages of a country s economic development. They just reckon that
China is not there yet. They brandish charts of metal intensity consumption
of commodities measured against GDP per head. By this measure China still lags
far behind richer countries such as South Korea and America for copper (see
chart 2) and most other commodities. The theory is that China should be
expected to catch up rapidly, with South Korea at least.
Too simplistic, say analysts convinced that the supercycle is about to
freewheel downhill. Nomura, a bank, observes that this measure ignores China s
high level of investment relative to GDP. Figures on per capita consumption are
only part of the story; China s vast population means the country already
consumes a huge amount of metal, making further bumper growth tricky. (In 2010
China used 577m tonnes of steel, compared with 91m tonnes in America.) Nomura
calculates that in 2011 China used 104 tonnes to generate $1m of GDP, compared
with 6.7 tonnes in America. The picture is similar for copper and aluminium:
China s economy cannot keep metal consumption growing at the current rates of
about 5% a year.
More factors suggest that metal intensity might waver, according to UBS.
Returns on fixed capital formation buildings, roads, other infrastructure,
plant and machinery are waning. The bank says that a frenzy of investment after
the credit crisis of 2008, when total bank loans doubled in three years, led to
seven years of infrastructure spending in a mere three years. Many of the
projects were either premature (subway stations standing lonely in bleak
landscapes waiting for a town to arrive), not terribly productive (motorways in
the hinterland rather than between the biggest cities) or not needed at all.
That investment splurge means that infrastructure spending may have peaked
already. The upshot, according to Julien Garran of UBS, is that supply has now
caught up with demand for coal and nickel, and will do so for copper next year
and iron ore in 2014. Mining companies have spent heavily trying to adjust to
China s hunger for minerals. Citigroup says they are poised for more capital
expenditure in the next five years than in the past 20 years combined. But if
it is true that China s appetite is less ravenous than expected, then
investment will fall too. Big projects due to start in the next three years are
locked in, but beyond that all are up for grabs.
Even if the supercycle is drawing to an end, China will still be a huge market
with enormous influence over prices. But the sheen may be fading, as on a lump
of steel left out in the rain.
from the print edition | Finance and economics