Prices plummet but could rebound: the meltdown of the US economy has already impacted on commodity markets worldwide. Is the panic set to continue or will underlying demand reinflate prices? M J Morgan provides an analysis.
The seesawing in both equity and commodity markets, even after unprecedented global government intervention and rate cuts, reflects this fact. Recent events are without any substantive corollary. Even the great crash of 1929 took place in a world that was as far away in substance as it is time. There did not exist then an integrated global economy, largely free-flowing capital markets and a constant flow of people and things from all over the globe.
So, let these uniquely complex circumstances stand as a caveat to any tentative attempt to consider what the consequences will be for commodity markets in general and for African commodities in particular.
What can be stated, pertinently and with a degree of confidence, is that this very conspicuous degree of uncertainty has led to a catastrophic loss of confidence. Whether either the US bail-out approach, or the much-emulated UK approach, will ultimately be a cure rather than simply a sticking plaster remains to be seen. Certainly Western economies are going into a recession but for how long? And at what cost to Africa?
Any difference between the cost of the bail-out and the returns the banks might be able to generate must be met out of taxation. Add this shortfall to the already existing US trillion-dollar deficit (due to the Iraq war and the appalling balance-of-trade deficit) and it is clear that the US economy is going to be in a weak state for many years--possibly permanently (if we heed the recent remarks of the Germany's Finance Minister, Peer Steinbruck).
Much of the market hesitancy about capitalising on what looks like good-value buying opportunities stems from the fear that what we may be witnessing is not just a correction but a shift from a unipolar to a multipolar world. Although African states fear the uncertainty of the fallout of these events for their domestic economies, they may well be better placed to recover faster as the dust settles.
Commodity markets, like those for equities and property, have responded by falling. Banks have, over the last few years, developed a much increased role in commodities trading. This means that as well as falling prices, counterparty credit risk has also disrupted trading for the same reasons that it has disrupted interbank lending--trust in the solvency of financial institutions has evaporated.
Despite the move from "over the The panic on world markets caused by the credit crunch has led to huge volatility in commodiity prices--even, surprisingly, in gold, normally considered a safe haven in times of economic uncertainty. counter" trading to exchange trading to mitigate this risk, this quarter's figures are likely to show the biggest fall in commodity prices for 50 years.
The Reuters/Jefferies CRB Index has fallen by nearly a quarter since the end of June--the worst-performing quarter since 1956. This has eroded the gains of the first half of the year and means the index is now down 1% on the year to date.
Similarly, the S&P GSCI index is down around 30% on the quarter and about 1.5% on the year. Interestingly, if one looks at the non-energy component of the GSCI index, the fall is around 21% on the quarter and nearly 12% on the year.
Industrial metals plummet
Strong falls in industrial metals, with lead, nickel and zinc being the worst affected, have led the way down. Copper has fallen 55% from its high at the start of July to $4,000 per tonne--the lowest it has been in three years.
This is largely due to anxieties about future Chinese demand. In 2009, China is anticipated to consume more than 40% of the world's production of oil, iron ore, steel, copper, aluminium and nickel. Therefore, all market participants are watching nervously to see how China is affected by recent events.
Worryingly, Chinese steel mills are demanding less iron ore, knocking suppliers for discounts on price (by around $25 a tonne for ore that would have cost $140 at the end of the last quarter) and have even been defaulting on some contracted imports of Indian iron ore.
This has been followed by the cancelling of 'unauthorised' oil-hedging contracts with a Goldman Sachs subsidiary, that would have lost the state oil company, Shenzhen Nanshan Power, money.
Of course, for much of this year the Chinese financial authorities have been focused on controlling runaway growth and the corresponding risk of inflation and this--along with the hiatus of the Olympics (and the antismog measures that came with it)--caused the crucial Beijing industrial area to coast along for part of the year. As anti-inflationary measures are relaxed, demand can be expected to strengthen.
Panic has lead to a highly volatile flight to gold, which is potentially good news for big exporters like South Africa and Ghana. As funds seek to unwind positions and de-leverage, investors redeem their stakes to reduce their own exposures. Once seen as a passe asset class, gold has attracted record speculative inflows from investors seeking a safe haven and a hedge against inflation, but after peaking in March at $1,030.80 / oz, it has now fallen back to under $720/oz.
The unwinding of speculative positions will frequently mean liquidating them into dollars, which has stemmed the dollar's decline and further arrest gold's surge. Additionally, jewellery demand still makes up 70% of the total market demand for gold and the outlook for jewellery is, unsurprisingly, negative.
Whilst, in the short term, brutal falls in price may be sticky, the long-term outlook for commodities is not so bad. When the dust begins to settle, China's economy is still likely to grow by a robust 8-9% in 2009, despite softening demand in the short term.
The Australian Bureau of Agricultural and Resource Economics estimates a rise in Australian commodity exports of around 43% between June 2008 and June 2009. Indeed, pension funds and long-term investors show no sign of following the speculators out of the market.
Against this, there is the bad news from the Baltic Dry Index, the index of shipping freight costs, an excellent barometer of economic activity. It fell to 1,506 points, its lowest level since November 2002, and a fall of more than 50% from its peak earlier in the year.
Commodities prices are particularly vulnerable to speculative pressure since it is possible to make margin purchases at around 5% of the contract value--allowing for significant gearing that, aggregated amongst all market participants, can lead to large swings in prices and a knock-on effect on costs for real-economy participants.
Mexican telecommunications billion-aire Carlos Slim has been campaigning for curbs on commodity speculators to be added to existing measures against short sellers in London and New York. So far this call seems to have fallen on deaf ears, but it is a remarkable indication of how times have changed that even billionaire George Soros has been an advocate of Federal intervention in the US, although critical of the approach proposed by the White House.
Platinum has fallen from a high of over $2,000/oz on 30 June to under $850 at the end of September, as US and EU car demand has slumped. Platinum is a component in the catalvtic converters that scrub a modern car's exhaust emissions.
Supply concerns have receded as Eskom appears to have overcome some of its grid issues in South Africa, where 80% of the world's platinum is mined. This decline, and the intense global uncertainty, has hit the London listed South African platinum smelter Brae-more Resources, down to nearly [pound sterling]3 (currently $4.65) a share, having peaked at [pound sterling] 24 a year ago, when it was valued at closer to $47.
The uncertainty has derailed the $7.75bn Xstrata bid for Lonmin, the world's third-largest producer of platinum, whose operations are based in South Africa. Despite Xstrata apparently having access to $15bn of syndicated funding, the company was unwilling to formalise its offer as the Takeover Panel had required it to do by 2 October.
The fundamentals for platinum remain strong, however, and most analysts think the outlook for major producers like Anglo Platinum is good. The possible implosion of smaller producers across the sector is likely, even if their mines are consolidated by larger players, which will result in a contraction in supply and thus in higher prices.
The biggest consolidation of them all, the BHP Billiton takeover of Rio Tinto, took a step forward when the Australian competition authorities, like their US counterparts, raised no formal objections. The bid is conditional on regulatory approval and now awaits the EU imprimatur by January 15th 2009. BHP Billiton chief executive Marius Kloppers said the bid would not proceed if EU regulators tried to foist disposals on the company. Australian/UK-listed BHP Billiton, the world's largest mining company, mines and smelts, amongst other interests, aluminium in South Africa and Mozambique, but Rio Tinto also has a huge presence in Africa. The company runs the Simandou iron ore mine in Guinea, large alumina concessions across Africa, the Murowa diamond mine in Zimbabwe, uranium in Namibia and the flagship copper mine at Palabora, the largest producer of copper in South Africa.
As further evidence of the mood of consolidation, Indian miner Vedanta has cancelled its proposed break-up which would have involved spinning off Zambia's largest copper mine, Konkola, into a separate company.
A looming bottleneck?
With global growth estimated at around 4% for the next two years, even if actual growth falls short, underlying demand for commodities is likely to remain strong. Un-derinvestment and a lack of expenditure on exploration are likely to create something of a bottleneck in supply in the medium term and drive prices higher.
Wheat and cotton are both down around 30% on the year, the former being very good news for the hard-pressed Horn of Africa states, particularly Ethiopia and Somalia, who are heavily dependent on food imports. In excess of 7m people are in need of emergency food aid in these countries, a figure that has sharply spiked this year.
The rice harvest in the US has been damaged by Hurricane Ike, and India has been restricting exports, increasing prices by about 10%, which has hit African nations in both West and East Africa, who have an increasing preference for the foodstuff.
While prices in the short term will be susceptible to the loss of speculative cash, especially as interest rates rise (commodities are a non-yielding asset), the underlying demand is there and the shortage of finance is likely to frustrate future supply.
Zambia is unlikely to face a collapse in copper prices similar to the 1970s and, once the storm is weathered, should reap the rewards, particularly if the "peak copper" doom-sayers are proved correct.
Increased car demand in Asia should prop up aluminium and platinum, good news for Guinea and South Africa. The one commodity really bucking the trend is cocoa, up 22% due to the poor harvest, great news for Cote d'Ivoire and Ghana.
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|Comment:||Prices plummet but could rebound: the meltdown of the US economy has already impacted on commodity markets worldwide.|
|Author:||Morgan, M. J.|
|Date:||Dec 1, 2008|
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