Commodities tipped to collapse

[rederob]

Almost a year since this thread began, and the base metals are running a repeat performance; ie running to new record highs in many cases.
At present, commodity market tightness is the rule and not the exception.
It is clear that supply side responses are inadequate, despite a 5-year ramp-up phase for most metal miners/producers.
Unless metals demand wanes, then prices in 2007 will be higher on average than 2006.
And we might also be setting-up 2008 for an even stronger year again!
That's certainly where I reckon we are heading right now. However, as always I review this longer term trend more deeply in the 3rd quarter.
Between now and then I'm not likely to move too much unless a clear meltdown comes into view.

Almost 2 years since this thread began.
Tin and copper have recently hit new record closing prices, and only zinc is wallowing amongst the base metals.
US housing starts - the few there are - have made no difference to the base metals market. Nor, it appears, has US industrial production.
2008 will mark the baton transfer, whereby metals markets dance to an Asian tune, and are likely to for several generations ahead.
Although copper has been a barometer for "industrialisation", each of the metals has displayed distinctively fundamentals-driven price action.
Copper itself is about to hit new highs as strike action and poorer year on year output from many producers keeps ratcheting up its price.
Importantly, input costs have gone through the roof and the metals market will never return to anywhere near the price levels immediately before the bull run commenced.
Despite the spectre of recession, there is nothing on the horizon suggesting commodity prices are about to collapse, which is the theme of this thread.

 

[Uncle Festivus]

Despite the spectre of recession, there is nothing on the horizon suggesting commodity prices are about to collapse, which is the theme of this thread.

This is the bit that concerns me. The thread topic was perhaps a bit premature, but the time is getting closer to when it will be proven in the affirmative.This last weeks action in everything is telling me some sort of blow off top is building, not based on demand criteria, but rather spec mania and 'flavour of the week' type piling into the latest fad to create a self perpetuating cycle - until it busts.
The first cab off the rank was the commodity masquerading as an alternative currency (with a little help from 'them').

The bottom line is there is way too much liquidity still in the global system looking for a home. A lot of money still has to be liquidated before the next cycle starts.

Food, fuel and metal. It may be good for BHP, RIO & the Arabs but to dictate price rises of over 60% to the Chinese for eg is implying that either manufacturers will have to absorb the cost increases or pass it on the the consumer. I think both are happening, which will seriously put a dent in the China machine as well as consumers having to pay higher prices ie global recession?

There is a limit to what the world is prepared to pay for them; demand destruction is quietly building the foundations for a collapse, only the exact timing is unknown. Maybe 20 June 2008?

 

[rederob]

This is the bit that concerns me. The thread topic was perhaps a bit premature, but the time is getting closer to when it will be proven in the affirmative.This last weeks action in everything is telling me some sort of blow off top is building, not based on demand criteria, but rather spec mania and 'flavour of the week' type piling into the latest fad to create a self perpetuating cycle - until it busts.

I have stopped counting the years that I have heard this argument.
Commodities, and every other sector for that matter, have their cycles.
What you need to determine is what is driving the cycle, and what is likely to halt it.
The demand destruction argument has worn very thin. Metal prices have not moved sharply higher (in the main) for several years. Nickel prices are about 40% off their peak, and copper is only around 10% higher than it was 2 years ago.
Oil prices have certainly climbed strongly, and coal prices are now shooting up as national energy needs are being squeezed by supply shortfalls. Again, evidence of demand destruction is not yet evident.
The "liquidity" argument is useful if a country needing energy has no money.
Countries need energy to prosper.
Even in recession there will be a strong demand for energy, and until it is priced out of reach, consumers will keep picking up the increasingly high tab.
I don't know the price levels that substitution and\or demand destruction impact the various commodities. I do know that there is a lot of data that suggests we remain a long way off.

 

[Markcoinoz]

Hi rederob,

I have been in commodities for the last 5 or 6 years.

How often have you heard the threat of the US collapsing would signal a slower demand for commodities and energy? It has proven to be a complete fallacy.

Chip Goodyear EX CEO of BHP a few years ago showed some brilliant 100 year commodity charts. The key to us entering a Supercycle was largely due to two major emerging economies China & India to enter the arena. The US is no longer
the most important country on the planet. Even if the US were to fall over tomorrow, the key to this can be seen with both China and India requiring massive energy & Resources for their own consumption.

Below is a fantastic read that someone posted from another forum.

Source Southern Cross Equities

According to an excellent report titled "Preparing for China's Urban Billion" by The McKinsey Global Institute (McKinsey & Company's economics research arm) China's urbanisation will lead to the following.

350 million: will be added to China's urban population by 2025- more than the population of today's United States.

1 billion; people who will live in China's cities by 2030

221; Chinese cities will have one million + plus people living in them- Europe has 35 today

5 billion; square meters of road will be paved

170; mass transit systems will be built

40 billion; square meters of floor space will be built- in five million buildings

50,000; of these buildings could be skyscrapers- the equivalent of constructing up to ten New York cities.

5 times- the number by which GDP will have multiplied by 2025.

It's worth noting that MGI's work is completely independent and has not been commissioned or sponsored in any way by any business, government or other institution.

Just have a think about some of those numbers above. 2025 is only 17 years away. If these forecasts are even half right the ramifications for the Australian resource sector and Australia are enormous. I realise we are in an equity market that currently can't see past tomorrow, but just consider what the ramifications of China's urbanisation could be. Remember, we are at the infancy of that urbanisation right now, not the end of it as the equity market wants to believe. Where is the raw material supply going to come from to meet China's ambitious urbanisation and GDP growth goals?

No wonder the talk is now Beijing is preparing to take a stake in BHP Billiton. Personally, I am surprised it has taken them this long to turn up on BHP's register.



The chart above was recently published by BHP Billiton. It's a great chart. The question copper bears have to consider is where is the supply going to come from to meet demand? The answer is "it isn't" and prices will continue to rise to reflect structural change in the demand supply balance (and the cost of getting it out of the ground) for industrial commodities, led by copper.

As we have written numerous times before it is the "supply side" response everyone is over-estimating, and particulalry so in the "red metal" copper. The "supply side" is simply not keeping pace with demand. Copper is the baromtere of resource sector sentiment and the correlation between the copper price and Australian resource sector share price performance is very high. The chart below shows LME spot Copper (red) vs. the ASX Materials Index (XMJ) in blue



Give or take a few periods where the equity market simply didn't believe the spot copper price was sustainable (and they were right for that short period), the direction of the copper price is highly correlated to the performance of the Australian materials index.

I realise many of you will be saying "of course it is", but even commodity super bulls such as myself hadn't realised that this correlation between the direction of spot copper and the Australian materials index (of which BHP is 45%) was so high. It's pretty clear that getting the direction of spot copper right is crucial to getting the direction of the Australian materials index, and its largest component in BHP, right.

Right now the conditions are clearly in place for a copper "super spike". We wrote as recently as the 11th of March on this topic but since then the copper market tighterned even further with global inventories down to just 2.5 days global consumption. The world is short copper; it is as simple as that.

For two years now I have been reading article after article about how slowing demand from the US housing construction sector was going to impact demand for copper and the price would retreat to the marginal cost of production. This is the consensus view.Those who have not analysed the supply/demand fundamentals in detail have come to the very simplistic conclusion that the US is the marginal consumer of the red metal. As the chart pack below from BHP confirms, that is not the case for Copper or any of the other industrial metals (or Oil). The commodity prices are clearly decoupling from the US economy because the US is no longer the marginal consumer or price setter.



According to recent Chinese customs statistics, January copper imports rose 16,400t m.o.m to 128,071t, the highest monthly level since April 07. Global production constraints continue with Chilean production down 1.4% to 439,123t.This represents the first yoy decline since 2006. In addition, the world's largest producer Codelco announced that 2008 production is expected to remain static considering the new Gaby mine will compensate for declining grades and lower production from other operations. Chile, which accounts for 35% of world copper production (and 30% of the worlds copper reserves) also has water and power issues that are not getting better.

Despite the constant predictions of increased supply from new greenfield projects and brownfield expansions, global copper production remains constrained due to lower grades from mature operations and chronic shortages in skilled labour and machinery. We believe global copper production might rise by just 1.5% this year against a backdrop of a 2.9% increase in world demand. This would result in a deficit of close to 200kt.

We expect static global production combined with 6-7% pa demand growth from China, is increasing the possibility of deficits continuing out to 2010. Since the last US recession China has accounted for 70% of the growth in world copper consumption. As a result China now accounts for 24% of global demand while the US has fallen to 10%. The days of $US0.70clb for copper are gone forever.

As a result copper drawdowns continue with year to date LME inventories down by 43%, representing just 2.5 days of consumption due to strong re-stocking from China and Europe. Currently the spot copper price is now only a few cents away from the record high of $US4.04 lb achieved in May 2006. Although speculative and hedge fund buying (short covering) has contributed to the strong year to date performance for copper there is no doubt that Chinese demand remains very strong.

It's also becoming clear that copper consumers believed the consensus view that copper prices were going to collapse and had aggressively run down inventories via de-stocking. That price correction has not come and it appears copper consumers are now dangerously short inventory with prices about to go through record highs (triggering technical buying) and analysts now looking for a supply deficit this year. That is a BIG change from forecasts of just six months ago which showed a substantial supply surplus this year. You watch the consensus copper price forecasts follow the spot price up from here. There is nothing surer than the commodity forecasters will chase the spot price higher over the remainder of this year. I saw some of these upgrades start yesterday, but they are classic rear-view mirror style ones that just push out the timing of the copper price collapse. Problem is they have been doing that for 5 years.

Continued........................

Cheers markcoinoz

 

[Markcoinoz]

Continued from previous post....................

Copper: $4.00, $6.00 or $8.00lb?

Pick a number for copper, but it isn't going to be $3.20lb that is consensus for cy2008. There is no doubt you could see a $5.00 copper price within months if the "super spike" scenario evolves, but the real question is what will the red metal trade with consumer buyers and traders competing to cover shorts, combined with demand from investors and those looking to diversify away from the USD? The answer could easily be $6.00 to $8.00lb.In these sort of "super spike" situations anything can happen because there is no inventory to come to market.

You could argue we are witnessing the start of a "super spike" starting right now in coal/iron ore and there's no doubt copper will follow. The world we see these stunning outcomes in coal and iron ore and realise there is no bubble in commodities, in fact they are underpriced. This is not a bubble; this is true structural change in the pricing of industrial commodities; however equity prices continue to discounting this is the peak of the cycle with commodity price collapse imminent. Short positions are at record highs despite the lowest multiples in the last 5 years, and everyone is trying to be the hero who "called the top of the commodity cycle". The problem is they are 20 years too early.

In my mind this just can't be the top of the commodity cycle because the vast bulk of investors and commentators believe it is. The commodity equities are priced for this scenario too. It was only two weeks ago that the vast bulk of equity strategists were telling you to underweight resources and overweight financials. That worked for two days, yet here we are today and that is the worst advice anyone could have given. Imagine "underweighting" resources ahead of a +200% increase in coking coal prices and the associated huge earnings upgrade? Imagine "underweighting" resources with copper at record highs, oil at record highs, and iron ore prices up a minimum of 71%? Why would you recommend doing that? Why would you "underweight" a sector with almost daily M&A activity, huge interest cover, and excess cash trading at a deep discount to the broader market? Why would you underweight the cheapest sector in the market with the largest net positive earnings revisions and fy09 earnings growth offering 3x the industrial market? Industrial earnings are still being downgraded; resource earnings still being upgraded.

Caught short

The point is we all get things wrong, but many, many people followed this "underweight" resources advice. I believe Australian institutions lowered large cap resource weightings this year. The hedge fund world outright shorted the sector via BHP, OXR, and FMG and they have been caught on the wrong side of this trade. BHP, OXR and FMG are crowded short trades and all three stocks are cum heavy consensus upgrades to fy09. Just to emphasise, have a look at the chart below of OXR underperforming the spot copper price in recent months. This is a 4 year chart which shows a very close correlation, expect for the last two months as shorters got stuck into OXR using the excuse of the ZFX bid and an imminent copper price collapse. OXR is a very crowded short trade.

OXR (blue) vs. Copper (red)



Listen to the bulks

The performance of commodities, both tradeable and contract based, during a US recession is trying to send you a clear message. What it is telling you is when the US economy stabilises and perhaps re-accelerates a little later this year you will get the true commodity "super spike". The bulks (coal, iron ore, manganese) are telling you what is coming for the tradeable commodities. The bulks are telling you the real supply/demand situation. The common view remains that when the US economy shows some signs of life later this year, in response to heavy rate cuts, that the USD will stabilise and investors will dump commodities. I reckon that is rubbish, why are Asian steel mills happy to pay +200% more for coking coal, and the strategists who are peddling that view "hope" it is right. The much more likely outcome is the "super spike" to reflect the tightness of supply, led by copper.

If we are right and copper moves into a new higher trading range it will take the whole materials complex with it. The outperformance of materials stocks over the broader financials/industrials will be dramatic, potentially more dramatic that at any time so far this cycle due to the dramatically superior earnings growth profile. The chart below is a 'daily' chart of BHP vs. the Australian Financials Index (XXJ) it shows you BHP has taken out the resistance level vs. the major banks is moving into a new trading range.

BHP vs. Australian Financials Index (XXJ); look out, a new level of domination starting (breakout)



The vast bulk of earnings upgrade potential lies in the Australian resource sector. The vast bulk of dividend upgrade potential lies in the Australian resource sector. The vast bulk of genuine balance sheet strength lies in the Australian resource sector. The vast bulk of M&A activity is in the resource sector. The vast bulk of outperformance will be generated by the Australian resource sector. It really comes down to whether you are prepared to back 1,000,000,000 urbanising Chinese over 350,000,000 already urbanised Americans.

I am genuinely moving into the "crazy" and very small camp that believes the genuine "super spike" in commodities could evolve later this year. That is completely contrary to the consensus view of imminent commodity price collapse. I can't think of one domestic investor who is positioned in the equity market for the "super spike" scenario, but I can name dozens who are positioned for the commodity price collapse scenario. Let's see what comes, but remember you never overtake anyone by staying in the same lane. It's probably also not wise to drive head on into a billion urbanising Chinese!

Go Australia


Charlie Aitken
Director
Head of Institutional Dealing
Southern Cross Equities


Cheers markcoinoz

 

[Adam A]

Great article Markcoinoz
Now where have i heard the name, of the writer of that article before?
Charlie aitken??

How about the one and only analyst to predict the rise of FMG from $5.50 before its 10/1 split to approx $78.00

 

[Markcoinoz]

Hi Adam A,

We should know within the next 1-2 years exactly where we are placed in this Supercycle. When Chip Goodyear first made mention of the Supercycle, he wasn't talking about a 5 or 10 year uptrend. He was talking to the tune of 25 years. So far he has been correct all the way. Where we are on the timeline thats the hard part to ascertain as we have 2 superpowers emerging.

From what i have read i agree with Charlie Aitkin that we are still in the early stages.

One thing for sure, its very exciting to have a few stocks that are involved in the history making of this cycle. If RIO & BHP should tie the knot it is going to be very interesting for some of the juniors.

The soft commodities sector is also an area that had been overlooked until recently.

Been 100% in Materials the last 5 years.

Cheers markcoinoz

 

[Adam A]

Interesting for some of the juniors,how do you mean?

Personally ive been spending a fair bit of time researching the fertilizer industry.

Seems to be plenty of room for growth, oil prices high, future expansion of bio fuels, change of diet in India and china to more protein based,limited supply of essential ingredients, phosphate potash ect with no synthetic substitute

Highest price share in both aus and canada are fertilizer companys

Best performing share in both aus and canada stockmarkets 2008 fertilizer shares

Its both exciting and scary with forcasts of future and curent food shortages

Interesting times. All the best of luck

 

[Markcoinoz]

Hi Adam A,

When i meant by some of the juniors, i am referring to I/O juniors such as
UMC - ROY - PLV - POL and a few others.

They have a great chance of possible T/O - JV's given the close proximity to infrastructure and high grade Hematite.

In regard to the Fertilizer Demand we are witnessing, MAK for Phosphate & RWD for Potash are standouts. There are also a few smaller ones that could benefit
just on the hype alone. STB with its Phosphate & Potash tenements.
COZ for Nitrogen.

I am in MAK as i still think its the best one to have.

Your right, we are heading into scary times with such food shortages in 3rd world countries and appears to be starting to hit developing countries as well.

Where this leads to i don't know.

However, it will add alot of inflationary pressure to many economies who can't afford it.

Thats the scary part

Cheers markcinoz

 

[Uncle Festivus]

This is the bit that concerns me. The thread topic was perhaps a bit premature, but the time is getting closer to when it will be proven in the affirmative.This last weeks action in everything is telling me some sort of blow off top is building, not based on demand criteria, but rather spec mania and 'flavour of the week' type piling into the latest fad to create a self perpetuating cycle - until it busts.
The first cab off the rank was the commodity masquerading as an alternative currency (with a little help from 'them').

The bottom line is there is way too much liquidity still in the global system looking for a home. A lot of money still has to be liquidated before the next cycle starts.

Food, fuel and metal. It may be good for BHP, RIO & the Arabs but to dictate price rises of over 60% to the Chinese for eg is implying that either manufacturers will have to absorb the cost increases or pass it on the the consumer. I think both are happening, which will seriously put a dent in the China machine as well as consumers having to pay higher prices ie global recession?

There is a limit to what the world is prepared to pay for them; demand destruction is quietly building the foundations for a collapse, only the exact timing is unknown. Maybe 20 June 2008?

Missed it by 11 days??

Hi rederob,

I have been in commodities for the last 5 or 6 years.

How often have you heard the threat of the US collapsing would signal a slower demand for commodities and energy? It has proven to be a complete fallacy.

 

[IFocus]

Missed it by 11 days??

looks like you have the Bragging Rights there UF, was reading a commentary the other day (cannot remember where) about how the run up wasn't about demand.............still waiting to see how the oil story unfolds $30 oil who would have guessed