Put together a falling US dollar and rosy growth forecasts from China and what do you get? If you guessed higher commodity prices, you get a gold star. Yet among the institutions, there’s mixed opinion about what metals prices will go up (or down) in 2008.
Merrill Lynch (NYSE:MER) says that a recession in the US and even more subprime trouble cannot possibly derail the commodity super cycle. Dow Jones news wires quotes Merrill’s research report, “For the mining sector, US demand is becoming less relevant, as China consumes two to four times more metal and comprises close to 75-100 per cent of demand growth for many commodities.”
Ah yes. China. We’ve reported here before that despite its mind-boggling appetite for base metals, China may actually just now be entering its most metals-intensive phase of growth. That suggests the case for increasing production is pretty strong, which puts all these proposed mergers in context.
Merrill also said, “While we don’t believe the Fed will allow the US to go into a recession, if it did, we believe that this would only impact Chinese demand at the margin.” Two bold statements for the price of one!
If the economy wants to go into recession, it will. The Fed can fight slower growth by making credit more widely available. And you can lead a horse to water…The trouble with using interest rates to rev the economic engine is that it doesn’t always work. People borrow when they feel confident…or reckless. When their frame of mind changes, not even an economic incentive to borrow can overcome the psychological wariness of taking on new liabilities.
That’s the theory anyway. A lot of traders have lost money in the last few years thinking consumers have finally reached their breaking point. So we’ll see.
And what about Merrill’s other statement than an American recession will only affect Chinese metals demand “at the margin.” This is obviously what Australian resource producers are hoping. But is it true. Will China keep buying Aussie ores and metals and coal right through a US recession?
It may not be as simple as that. That is, you might start to see some divergence in the performance of various metals. The entire asset class may not behave the same way. And really, why should it?
Metals prices are partly driven by the fall in the US dollar and Chinese demand. But the picture on the supply side is more complicated. Supply of metals is scattered all over the earth, with some countries being critical to certain metals. This variation in the location of production may begin to account for slightly divergent metals prices in 2008, some moving higher, some moving less high, and some not moving at all, or even moving lower.
UBS (NYSE:UBS) released a report yesterday that’s bullish on copper and aluminium, but not so much on other metals. USB’s Joachim Clement told journalists, “We feel the imposition of export taxes by China, one of the largest producers and consumers of base metals, to restrain the increasing prices and cool its rapidly expanding economy, could be the pivotal drivers of prices in 2008..This development may be particularly favourable for aluminium and copper.”
“UBS asserted that copper prices could outperform in 2008 due the surge of imports of refined copper, and a 23% increase in Chinese copper usage this year, which is anticipated to rise an additional 6% in 2008. UBS also anticipates that the present tightness in the concentrate markets may continue as low treatment and refining charges may result in reduced smelter output next year,” reports Mineweb’s Dorothy Kosich.
“Another crucial factor which is likely to come into the picture on further dips in prices is buying interest from the Chinese State Reserve Bureau as it seeks to replenish inventories,” Klement also stated. Production outages may put a floor under copper prices, too, he said.
So what’s UBS bearish on? Lead, nickel, and zinc. The reports mentions new zinc smelters in China coming on line in 2008 to keep that market well-supplied (and prices contained). UBS says demand from stainless steel producers will stay weak in 2008, keeping a lid on nickel prices.
So who’s right? Merrill or UBS? Well, Merrill is probably right that iron ore prices are going up at least 40%. Aluminium and copper are up in the air. Falling US industrial production or a recession, you’d think, would dent demand. But then there’s China.
In short, a blanket buy policy on base metals producers is probably not a good idea in 2008. Sorting out the various trends among the metals will be required. Of course, maybe they’ll all fall in unison on a global recession and none of this splitting hairs will matter. But we’ll continue to split them and let you know what we’ve found.
Markets and Money