A World Of Challenges

As already stated, the recent decline in commodity prices reflects a marked deceleration in global growth, heightened by hedge fund disinvestment — in many cases forced by fund redemptions, the withdrawal of credit or to cover losses in other financial markets. While recent inter-bank lending has shown signs of improvement — following government guarantees on inter-bank lending in Europe and capital injections into financial institutions to shore up their balance sheets — tighter credit will likely contribute to a more than halving of global economic growth from 5% in 2006-2007 to about 1.5% this year.

This will occur, even with relative strength in ’emerging markets’ such as China, where GDP growth should still advance by 7% in 2009, albeit down from 9.5% in 2008 and 11.9% in 2007.

Manufacturing activity in China fell month-over-month through the Q3 of 2008, likely due to plant closures to improve air quality during the Olympic Games as well as inventory liquidation. Activity continued to weaken in the fourth quarter — hurt by tighter domestic credit conditions and faltering exports, linked to contracting G7 activity. However, China decisively eased monetary policy in mid-September and announced a massive infrastructure spending program to maintain a reasonable pace of growth in 2009.

Metal prices are expected to bottom cyclically in 2010 — at levels above the lows experienced in the 1990s — underpinned by a somewhat higher level of ’emerging market’ demand. The recent sharp decline in prices is leading to proactive cutbacks in mine supply, while tighter credit conditions and the double-digit capital cost escalation of recent years will reduce capital expenditure or delay new mine development this year.

The extreme volatility in oil prices in 2008 was heightened by investment/ hedge fund re-positioning in financial markets. A U. S. dollar rally, linked in part to some improvement in the U. S. trade picture last June, encouraged funds to start reversing widely held financial-market positions put in place in early 2008 (e. g. ‘long crude oil futures — short the U. S. dollar’), pushing oil prices down last summer and early fall more-than-justified by supply/demand fundamentals.

However, the widening credit squeeze in the United States in September/October, resulting in massive U. S. government capital injections into the financial system as well as extensive liquidity initiatives (e. g. the purchase of asset-backed mortgage instruments from U. S. agencies) will widen an already large U. S. budget deficit and likely trigger renewed weakness in the U. S. dollar later this year.

In terms of base metals, copper prices dropped to US$1.37 in mid-December, after reaching a new record high of US$4.08 last July. However, prices were still yielding a modest profit margin of 8% over average world breakeven costs including depreciation, interest expense and royalties for most producers. However, the 10% highest-cost producers were not covering cash costs, given 30% cost escalation in the first half of 2008.

While demand indicators for copper have recently deteriorated and overall exchange stocks increased to 6.5 days of global consumption last November (up in London Metal Exchange warehouses and COMEX, but down on the Shanghai Futures Exchange), copper prices should perform better than other base metals in 2009. Numerous mine supply disruptions in Chile and elsewhere — which are continuing — have limited the buildup of stocks, planned new mine development is modest and China’s infrastructure spending program will likely boost copper demand by the second half of 2009.

Copper consumption in China will increase by about 5% this year — boosted by the country’s spending on power generation and transmission, railways and the port system — compared with gains of 8% last year and 16% in 2007. Copper scrap will likely be less available in 2009. However, world consumption may edge down in 2009, before picking up moderately in 2010. In the case of zinc, the global supply/demand balance has shifted into a surplus, with investment funds ‘shorting’ the market since last April. Initially, this reflected expectations of significant new mine expansion, but more recently a marked decline in demand linked to the global auto sales slowdown and very weak housing construction in the United States and Western Europe. Demand for galvanized steel has been pared back.

Zinc prices fell to a low of only US$0.47 in mid-December, with weak demand triggering an unprecedented response from smelters, who cut back production by 600,000 tonnes in late 2008. Miners have also curtailed production substantially and deferred new mine development.

While 2009 will be a challenging year for zinc miners, prices should begin to recover by the second half of 2010 — particularly if further production cutbacks are implemented.

Nickel prices, too, have retreated as the production of stainless steel slowed down in Asia and Europe in 2008. While China’s stainless steel demand will likely pick up again in the second half of 2009, a global capital spending slowdown will keep nickel prices at a low ebb this year.

Gold prices, traditionally considered a store of value and a hedge against economic uncertainty, held up well in 2008 compared with base metals. However, the broad-based strength of the U. S. dollar since mid-2008 (particularly against the euro), a largely ‘deflationary’ economic environment and weak oil prices have prevented gold from moving back up to its record high of US$1,032.70 per ounce in March 2008, despite financial market turmoil. Gold prices should, nevertheless, perform well for investors in 2009.

One product that has and will continue to do well is potash (a mineral-based fertilizer). Average spot potash prices at the Port of Vancouver were still at a record high of $US872.50 per tonne last November.

Sold-out contract volumes at major producers and a strike at Canada’s and the world’s largest producer bolstered market conditions last fall. However, new business has slowed substantially in recent months, given the pullback in international grain prices, tighter agricultural trade credit and the plunge in nitrogen and phosphate fertilizer prices.

While spot potash prices could ease moderately in the first half of 2009, prices are expected to remain high and annual contract prices to China — currently below international levels — are expected to increase. The industry is quite concentrated and typically cuts supplies to shore up prices, when market conditions turn quiet.

And finally, spot uranium prices were ‘oversold’ last fall, with some financial sector funds forced to sell material. However, prices have recently lifted off the bottom, and should be strong in the medium-term — underpinned by nuclear power expansion in many ’emerging markets’ and delays in the start-up of major mining projects.

India will likely resume purchasing uranium concentrates again in 2009. Iron ore and hard coking coal, on the other hand, are expected to decline in value by upwards of 20% in 2009 in some areas of the world, in view of the steep decline in global steel production. Skyrocketing hard coking coal and iron ore prices were a key factor behind steel price escalation last year.