When I was back in Australia everyone there told me about a two speed economy, fast driven by the commodity boom, and slow for everyone else. Well it looks like the fast will slow down and then Australia will be slow all over. Aivars Lode
Jul 28th 2012 | from the print edition
ASSIGNING analysts to cover the humdrum world of commodities and mining was once investment banking’s punishment for low-flyers or copybookblotters. Then China’s pulsating economy and appetite for raw materials sent the prices of industrial metals and bulk commodities soaring. It turned watching the dismal world of copper, zinc and nickel, and the mining firms that dug them up, from a role tantamount to constructive dismissal to glamour.
Can it last? Signs that China’s economy is coming off the boil—recent figures put annual growth in the second quarter at a mere 7.6% compared with the double-digit rates of the past few years—have led some to suggest the commodity boom is over and prices are likely to crumble. That prognosis looks premature.
The past decade has been a remarkable one for metals and bulk commodities—iron ore and coal. Consumers, desperate to get their hands on raw materials, paid well over the cost of production as demand outstripped supply, which was constrained by years of underinvestment by mining firms. Many analysts talked of a “supercycle”, a long-term surge in prices lasting for decades on the back of Chinese demand.
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The Chicago question
Chinese urbanisation has been the fundamental force behind that demand. Until the start of the millenium China, the world’s biggest producer of many commodities, was largely self-sufficient or even a modest exporter. Economic reforms have turned it into a manufacturing and exporting behemoth, and have prompted a vast movement of people away from the countryside to the cavernous factories and sprawling megacities of the new China. The housing, roads, railways and infrastructure supporting this shift required massive imports of minerals.
China’s steel production grew by 16% a year between 2000 and 2011. Around half the world’s steelmaking raw materials and two-fifths of its copper and aluminium now disappear down the dragon’s maw. The price of copper, which had fallen by 0.8% a year in the 1980s and 1990s to reach little more than $1,300 a tonne a decade ago, exceeded $10,000 a tonne in early 2011 and still stands at around $7,500.
A slowdown in China has led people to wonder whether the supercycle is over. The evidence suggests that it has reached a peak. Academics probing supercycles over the past 150 years reckon that the expansionary phase lasts between 15 and 20 years. Most analysts put the start of the most recent cycle around 2000 (see chart 1). HSBC, which thinks this cycle is just seven years old, concedes it faces the onset of “creaking middle age” and that a long senescence might follow. Ruchir Sharma of Morgan Stanley sees in a 200-year history of commodity prices a repeated trend of two decades of price declines followed by one decade of gains.
Commodity bulls and the world’s big mining companies have an answer to all this. They reckon that China still has far to go in building the cities, motorways and airports it needs. Marius Kloppers, the boss of BHP Billiton, the world’s biggest miner, points out that 200m Chinese swapped village for city between 2000 and 2010; he expects another 250m to follow over the next 15 years.
Even the bulls accept that demand for copper and steel tends to level off in the later stages of a country’s economic development. They just reckon that China is not there yet. They brandish charts of “metal intensity”—consumption of commodities measured against GDP per head. By this measure China still lags far behind richer countries such as South Korea and America for copper (see chart 2) and most other commodities. The theory is that China should be expected to catch up rapidly, with South Korea at least.
Too simplistic, say analysts convinced that the supercycle is about to freewheel downhill. Nomura, a bank, observes that this measure ignores China’s high level of investment relative to GDP. Figures on per capita consumption are only part of the story; China’s vast population means the country already consumes a huge amount of metal, making further bumper growth tricky. (In 2010 China used 577m tonnes of steel, compared with 91m tonnes in America.) Nomura calculates that in 2011 China used 104 tonnes to generate $1m of GDP, compared with 6.7 tonnes in America. The picture is similar for copper and aluminium: China’s economy cannot keep metal consumption growing at the current rates of about 5% a year.
More factors suggest that metal intensity might waver, according to UBS. Returns on fixed capital formation—buildings, roads, other infrastructure, plant and machinery—are waning. The bank says that a frenzy of investment after the credit crisis of 2008, when total bank loans doubled in three years, led to seven years of infrastructure spending in a mere three years. Many of the projects were either premature (subway stations standing lonely in bleak landscapes waiting for a town to arrive), not terribly productive (motorways in the hinterland rather than between the biggest cities) or not needed at all.
That investment splurge means that infrastructure spending may have peaked already. The upshot, according to Julien Garran of UBS, is that supply has now caught up with demand for coal and nickel, and will do so for copper next year and iron ore in 2014. Mining companies have spent heavily trying to adjust to China’s hunger for minerals. Citigroup says they are poised for more capital expenditure in the next five years than in the past 20 years combined. But if it is true that China’s appetite is less ravenous than expected, then investment will fall too. Big projects due to start in the next three years are locked in, but beyond that all are up for grabs.
Even if the supercycle is drawing to an end, China will still be a huge market with enormous influence over prices. But the sheen may be fading, as on a lump of steel left out in the rain.