Commodity Blog

Commodity prices have fallen sharply lately, but don’t count on a market rout.
China, the world’s biggest source of new resource demand, is still primed to swallow massive helpings of iron ore, coal, oil and other raw materials after the end of the Olympics. And supplies of many commodities — including copper — remain tight, despite a slowing world economy.
The most likely outcome for now, analysts say, is that commodity prices will settle at levels below their record levels of earlier in 2008, but still dramatically higher than a few years ago.
For natural-resource companies, that outcome presents a mixed bag. Commodity prices should remain high enough for companies to continue posting very big profits.
But resources companies also face higher costs than a year or two ago, so even if commodity prices level out, the first half of 2008 could prove to be a high-water mark both for earnings and for share prices.
Highlighting the risks, on Tuesday Anglo-Swiss miner Xstrata said it was temporarily shutting down a nickel-mining operation in the Dominican Republic because of high energy costs and lower nickel prices. Nickel prices are currently down about 65 per cent from record highs in May 2007.
More recently, oil has fallen about 20 per cent, copper 15 per cent, and wheat more than 30 per cent from peaks earlier this year. There have been similar drops in tin, zinc, palm oil and other commodities.
In part, the drops reflect a slowing global economy. The US, Europe and Japan are flirting with recession, and China’s gross-domestic-product growth, while still strong, is expected to ease to around 10 per cent or less this year, compared with 11.9 per cent in 2007.
The declines also reflect a change in sentiment among investors who fear a much sharper slowdown in China after the conclusion of this year’s Olympic Games in Beijing. Their worry is that China’s economy expanded faster than normal before the Games, with big investments in stadiums, roads and other infrastructure, and now will slow significantly without that extra stimulus.
But many analysts think those fears are overdone.
“The economy is clearly slowing this year, but I think it’s a mild slowdown,” says Andy Rothman, a China analyst at CLSA, a Hong Kong-based investment bank. The economy is “still fundamentally healthy, and over the medium term, certainly housing and infrastructure and urbanisation — the drivers of growth for commodities — are still there”.
In a report released in June, analysts at Goldman Sachs reviewed the economic performance of the last 10 Olympics hosts and found that many did, in fact, experience post-Games busts. But the places that suffered significant slowdowns tended to have economies that were dominated by their host cities, leaving them more vulnerable once the Games ended and the tents moved on. Countries with other big sources of economic activity often did well.
That seems to be the more likely outcome for China. BCA Research, a Canadian investment-research outfit, estimates that Olympics-related capital spending totalled $US43 billion ($49.3 billion), a large sum, to be sure, but only a tiny portion of the country’s $US3.6 trillion economy. Beijing accounts for less than 2 per cent of China’s fixed-asset investment. Most of the industrialisation — and hence, China’s resources demand — occurs elsewhere.
Some analysts reckon China’s growth could even accelerate later this year once the Games end. That is because China closed some factories and businesses and suspended some construction before the athletes arrived to prevent smog and congestion, and will restart them later. UBS estimates the facilities affected by shutdowns account for about 1–2 per cent of China’s industrial production.
Either way, the interruption will likely result in volatility in China’s orders for raw materials, making it difficult for investors to ascertain the country’s true underlying demand for some time to come.
If China’s economy does slow more than expected, it would more likely come from external problems than from a post-Olympics hangover. China relies on demand from the US and Europe to keep its massive manufacturing sector humming.
But if overseas demand fades further, China is expected to unleash more spending on public-works projects, analysts say, exactly the kind of investment that requires concrete, steel, and other commodity-intensive products. Already, government spending on infrastructure rose 42 per cent in the first half of the year compared with the same period in 2007, CLSA says, a significant increase from a year earlier when it grew 19 per cent.
Investors shouldn’t expect a repeat of the record-setting run that sent oil to $US145 a barrel in July, though, analysts say. Many believe commodity prices were kicked higher then by speculators who later exited the market, in part because of a strengthening in the US dollar, which is often associated with weaker commodity prices.