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Commodity Prices to Bottom in 2009: Banks

January 1, 2009 at 6:48 by Andriy Moraru

While TD Bank sees the commodities market starting to rebound in the second half of 2009, followed by more pronounced price increases in 2010, the World Bank believes that, over the long term, commodity prices will remain substantially below recent bull market highs.

“The commodity market boom has come to an end,” the World Bank says. This boom has been the most pronounced since 1900, and was caused by rapid demand growth which was not matched by supply growth. In a report entitled “Global economic prospects — commodities at the crossroads,” the bank says that the boom has ended because of slower GDP growth, increased supplies and revised expectations.

The World Bank does not agree with observers who say that the global economy is moving to a new era characterized by relative shortage and permanently higher commodity prices. Over the long run, commodity prices are expected to fall, but not to 1990’s levels, since such low prices will suppress exploration and new development in the resource sector.

Over the next two decades, GDP growth rates will slow down because of slowing population growth and moderating income growth, in turn putting a lid on commodity demand growth. Moreover, technological progress should improve the efficiency of both production and use of commodities, ensuring that supply keeps pace with demand.

The World Bank says that, while commodity prices are likely to be higher than they were in the 1990’s and early 2000’s, a period when prices were depressed by excess supply, “the recent peaks (in prices). .. are unlikely to be the new norms,” since demand is not expected to outstrip supply over the long term.

The World Bank sees a marked slowdown in growth rates in the coming year. The bank projects that in 2009, investment in developed economies will shrink 3.1%, while investment in developing economies will grow by 3.4% — a sharp pullback from the 13% growth seen in 2007. The bank forecasts that the global economy will grow by 0.9% in 2009. Developing economies are projected to grow by 4.5%, well below the 7.9% growth rate seen in 2007.

Phenomenal growth in China’s GDP has led to growth in metal intensity in the economy, defined as metal consumption per unit of GDP. This trend is explained by the boom in investment, manufacturing and exports in China. Currently, metal intensity in China is four times higher than in developed countries and twice that of other developing countries.

China’s metal intensity is expected to stabilize in coming years and then start falling as high investment rates in the economy moderate, and the movement of manufacturing capacity to China from the rest of the world likewise slows down. Another factor which will decrease metal intensity in China is the changing make-up of the economy, where the share of services will increase at the expense of construction and manufacturing.

If China’s metal intensity stabilizes and then falls in coming years, global demand growth for metals, which has exceeded GDP growth rates, should first decline to match GDP growth rates and then decline even further to below GDP growth. The World Bank forecasts that, between 2015 and 2030, the global demand growth rate for metals will be 2.7% per year.

Turning from metals to energy, the World Bank says that future energy demand growth depends heavily on the pace of technological innovation in the automotive sector. Energy efficiency in the transportation sector is key to moderating demand, since 75% of energy demand growth is projected to come from this sector.
The World Bank believes that the prospects for technological improvements in the automotive sector are good, using technologies such as flex-fuel, hybrid cars, plug-in hybrids, electric cars and hydrogen-powered vehicles. Together, these have the potential to double fuel efficiency. The bank believes that, by 2050, the market share of such innovative vehicles can reach 90% in the developed world and 75% in the developing world, which will help reduce dependence on oil.

The bank forecasts oil consumption to grow to 114 million barrels per day in 2030 from 87 million today. Energy consumption as a whole is projected to grow at a faster pace, since consumption of other energy forms (such as coal, natural gas etc.) will grow faster than oil demand.

“Over the next 20 years, supplies of extracted commodities are likely to remain ample,” the bank says. The pace at which supply in the oil and metals sector catches up with demand depends on how quickly the supply of labour and supply in the heavy and specialized equipment sector can be restored. Capacity in these sectors has been reduced by years of low prices and weak investment, leading to long delivery times and high costs.

Recent high prices have helped address these capacity constraints. With the current recession, and with lower commodity prices, investment demand has fallen, and demand for specialized and heavy equipment has fallen in tandem, as have equipment prices. Despite this, prices are projected to remain relatively high and there will be a backlog in equipment deliveries for the next several years.

Although more and more resources, both metals and energy, are extracted every year, which means that less and less remains, it is unlikely that resources will be exhausted anytime soon, the bank says. Historically, reserves of both oil and metals have tended to rise faster than the depletion rate through extraction. In the case of oil, reserves have tended to remain at 40 years of anticipated consumption. This is because, when companies tally reserves, they tend to include only resources that can be readily extracted, which excludes sizable known resources.

The bank expects that more resources will be discovered, even though they are likely to be lower grade or more remotely located, and therefore more difficult and costly to produce. Nevertheless, advances in extraction technology will likely offset these impediments. The long-term oil price is expected to be US$75 per barrel in real 2008 dollars, a level which will allow economic production from oil sands. The bank expects that the oil price will also average US$75 per barrel in 2009.

Even if the World Bank’s projection turns out to be partly wrong and certain resources do become scarce, the bank says that alternatives will start coming into play. For example, if the pace of oil discoveries declines, the rising oil price will make alternatives such as coal, nuclear, natural gas and renewable energy more attractive, as well as stimulate conservation and technological change. However in such circumstances alternative energy sources will also become more expensive.
The World Bank summarizes its forecast by saying that under reasonable assumptions the supply of commodities is likely to increase rapidly enough over the long run to meet anticipated increases in demand at prices that are lower than the current levels. (The report was issued on November 20, when commodity prices were somewhat higher than now.)

TD Bank economist Dina Cover focuses on short-term prospects for commodities. She has downgraded prospects for the global economy in 2009, projecting growth at a mere 0.5%. The U.S. economy will shrink by 2%, and growth in the Chinese economy will slow to 7.6%. Since the U.S. and China are the world’s largest consumers of many commodities, demand will be hit hard, particularly for oil, coal and industrial metals.

As a result, the TD commodity index is projected to fall by 15% from mid-December levels, for a 60% peak-to-trough decline, and it will bottom in the second quarter of 2009. This may drag the Canadian dollar further down, which should help cushion the effect of falling commodity prices on mining companies.

Energy and base metal prices will decline the most, since both consumer and industrial demand for these commodities will decline. Although some mining companies, notably zinc and nickel miners, have slashed production, demand has fallen much more, so prices will remain under pressure in the short term. For example, the oil price is now expected to bottom at US$30 per barrel.

As for gold, TD forecasts that fears about deflation and disinflation could put downward pressure on prices in the near term, but a projected drop in the U.S. dollar in 2009 will support the gold price.

The global economy will start firming toward the end of 2009 and into 2010, lifting commodity demand and prices. TD projects a 55% rebound in the TD commodity index by the end of 2010, led by more than doubling of the oil price to US$75 per barrel. Excluding energy, the index will rebound by only 22%. Commodity prices are not projected to reach their boom peaks, since global economic growth in 2010 is forecast at a lukewarm 3.2%, substantially below the 4–5% growth rates seen during the boom.

Another factor which will limit commodity price appreciation is lower investment demand, since other asset classes will also rebound, so they will compete for the same investment dollars.

TD projects that oil will cost US$45 per barrel in December 2009, rising to US$75 in December 2010. Thermal coal in Australia will cost US$65 in December 2009, rising to US$100 in December 2010. The silver price will be US$9.60 per oz. in 2009, rising to US$10.50 in 2010. Aluminum will cost US75¢ per lb. in 2009, rising to US$1 in 2010. Copper will cost US$1.50 per lb. in 2009, rising to US$1.80 in 2010. Nickel will cost US$5.15 per lb. in 2009, rising to US$6.50 in 2010. The zinc price is projected at US48¢ per lb. in 2009 and US70¢ in 2010. Uranium oxide is projected at US$52 per lb. in December 2009, and US$65 in December 2010.

TD forecasts that the only commodities which will see price falls between 2009 and 2010 will be gold and newsprint. The gold price is projected at US$815 per oz. in December 2009, falling to US$700 in December 2010.

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