metals super cycle rolls on

Metals super cycle rolls on

By David Uren

13may06
IT seems too good to be true, but commodity prices were at fresh records again this week after gold hit a 26-year high.

Gold prices hit a 26-year high of $US721 an ounce yesterday, 2 1/2 times the low of $US269.50 reached in May 1999.

Copper briefly hit an all-time record of $US8790 a tonne, six times its 2001 price. Zinc, at $US3880, is 500 per cent up on its price just three years ago. Nickel at $US21,200 a tonne has increased fivefold since 1998.

Far from losing steam, the commodities boom is gathering fresh strength and is poised to reshape the face of business and the economy.

The upward march of the resource companies is set to continue, accompanied by a rising Australian dollar.









Manufacturers and export service industries, such as tourism, have complained loudly about the strength of the currency, but those who track the relation of the Australian dollar to mineral resource prices say it is seriously undervalued. Markets agree.

The federal Government, which was expecting no further gains in commodity prices in 2006-7, and declines after that, will again be swamped by an abundance of company tax revenue in next year's budget.

It will face increasingly shrill calls to redistribute gains to those the boom has left behind.

The idea of a super cycle in commodities has shifted from the realm of theory and is fast becoming a reality.

Base metals prices have risen by more than 40 per cent this year in the face of rising world growth and falling stocks.

"It is not just metals. Almost every commodity asset class, whether it is crude oil, precious metals, industrial metals, sugar or even bananas is going bananas," says ABN-Amro's global head of commodities, Nicholas Moore.

"All these industries are facing similar problems of a very lethargic supply-side response. It is partly the result of years of underinvestment, partly a physical shortage of things such as mega-tyres for 250-tonne trucks, and partly the lack of skilled labour, whether that is geologists, miners or engineers."

Mr Moore says inventories for metals traded on the London Metals Exchange have dropped to critical levels, while investors, believing commodity prices are a one-way bet, are crowding the market.

Total metal stocks are valued at $US5.5 billion ($7.1 billion), while bought positions are in the region of $US200 billion.

"A lot of money is trying to get into a small sector. The huge speculative attention means this cycle will definitely be stronger for longer."

Macquarie Bank's London-based chief commodities analyst Jim Lennon says the global economy is now expanding at its fastest rate for 30 years.

Every month since last October, surveys of the world's leading economists have resulted in upgrades to forecast growth this year.

At the same time, surveys of commodity analysts have resulted in downgrades to their estimates of supplies.

Mr Lennon cites the example of Australian coking coal and iron ore exports. Coking coal shipments in the first three months of this year were 5 per cent down on the same time last year, while iron ore sales were down by 3 per cent.

"From the commentary we get from BHP Billiton and Rio Tinto, they are highlighting that they are struggling to ramp up production globally."

Last year, many thought the boom would be short. Demand for some commodities fell, mainly in the US and Europe.

Lennon says customers were supplying themselves from their stocks, and some commodities, such as steel, had price falls. Steel demand fell 10 per cent in Europe and 5 per cent in the US. Copper demand also fell. Now the stocks are gone and demand is rising. The International Iron and Steel Institute forecasts 7.3 per cent growth this year.

Lennon says LME stocks now cover fewer weeks of production than at any time in the last 35 years.

Although a lot of new supply is being planned over the next five years, the world economy is incredibly buoyant. For many minerals, mines have been running flat-out to meet the surge in demand are now running into problems, with lower grade ores and forced maintenance interruptions.

Lennon says commodity booms have never come to an end because supply catches up to demand. Rather, they have been caught short by recessions: "What you need is a good old-fashioned recession, but that is nowhere on the horizon."

Debate is held about whether the market is taking leave of its senses, and whether current prices can be justified on fundamentals. Lennon notes that in real terms prices are lower than in the late eighties, or in the either of the two booms at the beginning and end of the seventies.

Citigroup equities strategist Adrian Blundell-Wignall likens the current boom to that which accompanied Japan's industrialisation in the fifties and sixties.

He says most of the advance in resource prices occurred at the beginning of that period, although prices then stayed high for an extended period. But he says commodity prices in real terms are already at the level they reached late in the process of Japan's industrialisation.

The key to the survival of a super cycle, he says, will be China managing growth, and the US containing the risk of inflation.

Citigroup has been forecasting that the commodities boom would lift the Australian dollar higher since last year.

Many analysts and the Reserve Bank, have noted the Australian dollar is not nearly as high, when trading at about US75c, as its traditional relationship with our terms of trade would suggest. Blundell-Wignall says there is a pattern for the dollar initially failing to react to an improvement in the terms of trade, and then over-shooting. He expects the currency to move past 80c in six to 12 months.

The commodity and currency moves have implications for both the economy and business.

In this budget, Treasury said a long period of high minerals prices would raise average living standards in Australia, but cause some dislocations. It would shift capital and labour out of other sectors of the economy, including manufacturing, agriculture and services. "It would be counter productive to provide trade protection of long-lived publicly funded economic support to sectors or firms that can no longer generate an economic return."

Treasury says achieving such a shift of economic resources will require great flexibility from Australia's economy, and more work on competition and pricing policy in transport and energy.

If the new prosperity is permanent, it would also reduce the need for the Government to run large budget surpluses.

Treasury is taking a cautious approach of assuming the commodity boom will start fading in 2007-8. But the prospect of further large gains in terms of trade this year would leave the Government again in a decision of how to deliver a surplus.

Blundell-Wignall says the shifts will affect share investors.

Although British commodity analysts emphasise the weight of speculative interest in minerals markets, this has not yet extended to resource companies, whose prices have risen in line with profits.

Resource companies are trading on ratios of about 19 times profit, compared with peaks of over 30 in previous booms.

Blundell-Wignall says one can either assume the boom is permanent, in which case a much higher price-earnings ratio is warranted, or that the current high spot prices fade back to the long-term trend.

As a commodities analyst, he says caution dictates the former.

"The last thing you want to be is the guy who called the tech boom in 2001. That is a career-destroying move."

The effect on manufacturing companies will not be simple, as many have already shifted much of their sourcing overseas.

However industries that are truly exposed to international pricing, such as tourism or education, will feel the shift in exchange rates directly.

Australian investors in companies that have globalised their operations will also suffer, as international returns devalue.

Australian Industry Group chief executive Heather Ridout says it is important that Australia retains a balanced economy.

"An economy driven by mining, which is 6 per cent of GDP, is not balanced."

She says the worst of the commodities boom is Australia finds it much harder to generate the bright young exporting companies. Established companies may adjust, but new entrepreneurs cannot break in.

"We need a broader productivity agenda and give companies facing strong headwinds from commodities more support in their export effort. Treasury would argue that at the aggregate, all these things are good when you have these influences but there is collateral damage, which manufacturing is already experiencing.

"I think it is hollowing out. Some would say it is being weeded out. But we need to do something, because one day even a super cycle will end. And what will Australia be left with? A quarry?"