Behind the current short-term fluctuations linked to shifting growth prospects lies a powerful uptrend in commodity prices. A deep-seated change in lifestyles in emerging countries is creating new needs in a self-sustaining process that generates ever more demand.
At its latest plenary session at the beginning of March, China’s National Assembly confirmed the direction in which markets are moving: industrial metal prices are likely to continue a rally that started a decade ago.
Nobody can or should invest in commodities unless they are convinced of the potential demand for capital goods and infrastructure needed to underpin endogenous economic growth, as opposed to export-driven expansion alone.
According to the Appliance Manufacturers and China Building Association, copper consumption already amounts to 41 kilograms per home. Looking at China’s 12th five-year plan, the proportion of the country’s population living in urban areas will expand from 47.5 percent today to 51.5 percent in 2015; this urbanization will require tens of thousands of kilometers of railways, roads and piping. It will also require new power stations to meet energy demand, and copper and copper derivatives will be needed here as well.
Whatever the sector, requirements are staggering and the figures speak for themselves. According to the International Copper Study Group, China accounted for 7.87 million tons of the 22 million tons of copper used worldwide in 2009. By comparison, Western Europe, the planet’s second-largest consumer, accounted for “only” 3.13 million tonnes. A few figures from the production side put this trend in perspective: Escondida, the biggest copper mine in Chile, can produce a maximum 1.3 million tonnes per year, and 1.09 million tonnes were actually extracted in 2010. Chile’s total output increased 0.5 percent last year.
The 8 percent increase seen in world demand in 2010 should be compared with a 4 percent increase in output. “Shortfall” is a euphemism, and prices are bound to rise further even without consideration of strategic stocking. Having surged to almost $10,200 per ton, copper prices are now fluctuating just above the $9,000 mark. This level looks attractive in the long term.
The emerging-country demand argument may be a cliché, but it represents the stark reality of the situation, especially given China’s latest development plans. Identifying demand factors is the best means of evaluating changes in prices.
Cashing in on calamity
Since February 15, 2011, issues relating to world growth have weighed on all commodity prices. The Japanese disaster has followed instability in the Middle East and North Africa (MENA), clouding the prospects for activity and fuelling price volatility. Yet while instability effectively creates a tax on consumption via crowding-out effects, Japan’s predicament actually strengthens the upswing in commodity prices. After all, reconstruction efforts will require purchases of copper over and above the country’s 1.22-million-ton consumption in 2010. Short-term volatility should not mask a long-term trend bolstered by rising demand for a product of limited supply.
Copper use by region in 2009 (millions of tons)
In terms of the upheaval currently rocking the MENA region, the outcome is uncertain due to the social factors that are contributing to these crises. The movement of revolt, which derived its power from the ever-widening gaps within these societies, has taken a turn that could threaten stability across the region. None of the main producers has been affected for the time being. The action taken by the Gulf Cooperation Council and conciliatory gestures in the form of handouts are sure signs that the regimes in place are feeling the pressure and acknowledging the risk of social unrest.
The increase in real demand masks a political dimension, too. Just imagine the social unrest if, for want of basic materials, China fails to deliver the 38 million new homes it has promised under the current five-year plan. Access to such resources is vital and readily explains Chinese and Indian commodity-related acquisitions and equity stakes.
That said, premia for high-probability events are rising, as the case of the insurance market shows. Soaring oil prices against a backdrop of instability in the Middle East and North Africa are a salutary reminder of that fact. In an inversion of the usual relationship on the commodity markets, volatility recently rose in line with a sharp increase in crude oil prices. This insurance premium is apparently $10-$15 per barrel, a stark pointer toward geopolitical uncertainty.
The synchronization of growth cycles is reflected in a combined surge in energy demand. As with copper, the factors driving up energy prices depend above all on growth. Commodity prices are often set by marginal demand, with the disappearance of a few hundred barrels of oil per day out of a total of around 87.5 million barrels consumed per day triggering immediate price adjustments to the upside, with the size of the move depending on the quality of the oil concerned.
The 2008 crisis probably boosted awareness among major consumers such as India and China that they have to invest if their populations are to benefit from endemic growth. In the present recovery phase, demand for commodities is now increasing among the major developed countries. This amounts to a long-term demand shock in the context of insufficient pre-crisis investment, compounded recently by geopolitical risk.
This is an explosive mixture that is likely to drive commodity prices higher still, amid heightened volatility that reflects wavering growth expectations.
Bertrand Carlier is the manager of Bel Air Fixed Income & Commodity Funds at Credit Agricole Suisse
