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Metal Madness: Commodity Boom and Bust Cycles


  • Metals have recovered a bit, but even miners are bearish now.
  • Forecasts are not inspiring for at least the next two years.
  • A lot of indicators suggest that there is another commodity boom cycle in the making as the global economy continues to grow and investments in mines decline.

Introduction

Commodities had hit rock bottom this winter when iron ore prices went below $40, and alongside iron ore all other commodities except gold were in a slump. This slump in prices provided great returns to investors that had the guts to buy when most thought the world was over for miners. Iron ore prices have rebounded by more than 50% since their lows but are still far from their historical highs.

1 figure iron ore 112 months
Figure 1: Iron ore 12-month chart. Source: Index Mundi.

As similar patterns have affected other commodities, this article is going to provide indications as to whether the rebound is going to continue or if it is just a dead cat bounce.

2 figure bloomberg commodity index
Figure 2: Bloomberg commodity index for the last 5 years. Source: Bloomberg.

Miners Are Not So Bullish Anymore

Miners had usually been bullish as they estimated that lower prices would push high cost producers out of the market, and with less competition, allow more profits for the ones that survive. But the strategy did not work that well, nor that fast.

According to the second global iron exporter in the world, Rio Tinto (NYSE: RIO), the rebound in iron ore prices is not sustainable as more production is coming online and will offset improving demand from China. RIO’s CEO is even warning investors that iron prices will remain volatile.

The recovery in iron prices was influenced by strong demand from China that produced a record high of steel in March and will probably increase its production in April and May. This is good news, but the increase in steel prices and iron ore prices brought to the rapid reopening of capacity that had been shut or suspended that will soon put downward pressure on steel and iron ore prices, again.

The CEO of Antofagasta, a major copper producer, Mr. Arriagada recently announced that copper prices have recovered but still face pressures and are likely to remain subdued for at least another two years as surpluses are expected in 2016 and 2017.

In the Aluminum sector, the outlook is also bearish for 2016 and not much brighter for the next 5 years.

3 figure IMF forecast
Figure 3: International Monetary Fund Aluminum Forecast. Source: Knoema.

An indication of how bad this forecast is comes from the fact that Alcoa (NYSE: AA) is not profitable at the above prices as it breaks even at an aluminum price of around $1,800 per ton.

The situation with coal isn’t any better. The US Energy and Information Administration (EIA) forecasts continued oversupply, even with decreased production.

4 figure eia coal supply and demand
Figure 4: EIA coal supply and demand outlook. Source: EIA.

With prices continuing to decline, and omnipresent oversupply, the coal industry will see even rougher times ahead.

Silver is also not in a good situation as its price rebounded 15% from its bottom in December 2015, but is at the same level as it was exactly a year ago and still 63% down from its 2011 high.

5 figure silver prices
Figure 5: Silver prices since 2011. Source: .

The outlook for silver isn’t that positive as falling silver intensifies in electronic and photovoltaic sectors, and declining trends in photographic applications are contributing to overall lower consumption.

6 figure silver forecast
Figure 6: Silver outlook. Source: World Bank.

The story with gold is different than the above mentioned metals as gold is considered a safe haven in difficult economic times. As difficult economic times seem to be over and the likelihood of the FED increasing interest rates yield strengthens, baring assets will be favored and gold should decline. Physical demand for gold has been weak lately as the two largest gold consuming countries, India and China, lowered their demand. In India, an excise tax of 1% was announced on gold and many jewelers went on strike, while in China demand is weaker due to a slowing economy. As the FED has become more hawkish on interest rate increases, gold has lost 5.9%.

Resource Development in an Era of Cheap Commodities

Commodities peaked in 2011 and have been falling ever since. What happened is that with high prices spurred by growing demand from China, many new projects were developed as they were considered profitable with the high prices.

At the moment there is an opposite trend as many resource development projects are put on hold, showing exactly how mining commodities is a purely cyclical industry. With agriculture, higher prices quickly prompt farmers to plant more of that commodity and cycles are shorter. With mining, it is very difficult to just increase production because it is a very long an expensive process to find and develop a mine, and all the low hanging fruit has already been mined.

7 figure copper and gold lead times
Figure 7: Distribution of discovery to production time. Source: Pumpkin Hollow Project.

As the development of gold or copper mines takes at least 5 years, with 12 years being the most common for copper and with some taking more than 60 years, with the current postponing of investments in research development we might soon witness another commodity super cycle as we have witnessed in the first decade of this century.

Conclusion

Low commodity prices have several influences. It’s not that strange that Europe can’t reach any inflation let alone the 2% targeted level, and that the FED is also struggling to reach the target no matter the low interest rates or quantitative easing. As everything that is produced begins with commodities, this is also where the pricing starts. As soon as commodities pick up, inflation will also soon follow, but according to forecasts that should not happen in the next year or two. As stock markets always anticipate what is going on in the market, investors wanting to take advantage of the future commodity boom cycle should position themselves before it is too late.

Low commodity prices also raise concerns about the ability of commodity-exporting emerging markets and developing economies to withstand shocks in the global economy, as their main source of liquidity is exporting commodities. But those economies would benefit from increased commodity prices and markets would soon grow.

Lower investments in research and development and a heathy global projected economic growth of 3.4% by the International Monetary Fund will eventually result in a boom for commodities. When that will happen is unfortunately beyond the scope of this article, but at least it is clear that it will happen.

 

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