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Prices 'will stay sky-high for years'

By Tom Stevenson

Last Updated: 9:25pm BST 27/07/2007

Europe's top-ranked natural resources investor has given warning that sky-high metal prices will defy the sceptics for years to come.

Evy Hambro, who manages Blackrock's World Mining Fund, said investors continued to underestimate the mismatch between soaring demand for raw materials and the mining industry's ability or desire to increase supply.

"We find it astonishing that, some six years into a cycle, the analysts are still getting it wrong", Mr Hambro said. "They have been too pessimistic for six years in a row and seem to be behaving like desperate gamblers, always betting on the same number."

Commodity analysts have underestimated the price rises for almost all industrial metals in the first half of 2007. In January, the consensus forecast for the average nickel price in 2007 was $11.76 a pound, but in the six months to June it has already averaged $20.27. Analysts have also underestimated the price of both lead and tin by more than 50pc.

According to Mr Hambro, who has topped the S&P Commodity and Natural Resources sector over three and five years, just four developing countries will use more aluminium, copper and oil by 2015 than the entire world consumed last year. He said that, on current growth projections, Brazil, Russia, India and China will by themselves need 140pc of last year's global aluminium demand, 105pc of copper output and 121pc of all the oil pumped around the world in 2006.

Although China consumes more aluminium than the United States, on a per capita basis the US still uses around three times as much. India's per capita use of aluminium is even lower than in China, so demand in both countries is almost certain to rise sharply as living standards increase towards the levels enjoyed in developed countries. It is estimated by BHP Billiton that the amount of copper that will be used in the next 23 years will exceed total global consumption since 1900.

"Because of this, although prices will be volatile, they will remain stronger than most people anticipate," Mr Hambro said. "This is why Rio bid for Alcan."

Blackrock believes that the natural resources "super-cycle" - an unusually large and extended price cycle - is still relatively immature. The fund manager said that the final "optimistic" phase of the cycle remained well in the future. Instead, investors are mired in a "pessimistic" frame of mind, during which analysts typically underestimate earnings growth and undervalue companies.

Although Rio Tinto's shares have more than doubled in the past two years, they have failed to keep pace with soaring earnings and are priced at little more than half the multiple of earnings they were valued at only four years ago.

In this middle phase of the super-cycle, which developed out of an earlier "despair" phase of rock-bottom prices and little investment in the sector, companies usually prefer to buy cheap corporate assets rather than take the risk of building up their own productive capacity. Since the start of 2005, deals in the sector worth over $200bn (£100bn) have been struck, with many of the leading producers of metals - companies like Inco, Falconbridge and Alcan - taken out by stronger competitors.

Consolidation has dramatically changed the mining landscape, with the top three nickel producers controlling 72pc of the market, compared with 52pc in 2000. In aluminium, the top three control 34pc against 23pc seven years ago.

According to Mr Hambro, this emerging oligopoly should result in prices remaining stronger for longer because big diversified companies are less likely to be under pressure to increase supply in any single metal than a company focused on only one commodity.

Not until optimism took over and the sector's valuation rose to a premium did companies finally embark on "grand supply expansions", Mr Hambro said. Only then should investors worry that the cycle was close to a peak.

Takeovers had become the preferred route to expansion, Mr Hambro added, because companies were valued on the expectation that metal prices would fall back in the next few years and because acute shortages of mining basics such as tyres and trucks made expanding supply too risky and expensive.

Rio Tinto has warned that it is now forced to wait for up to two years for delivery of essentials like power generators which, until recently, were available in half the time.

Tyres, which used to be delivered within three months, take two years too. The waiting list for grinding mills can be more than three and a half years.

In previous super-cycles, prices have continued to rise for between 10 and 20 years.

Commodity prices started rising from their recent low in the final quarter of 2001.