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I have been calling
for a base metals bust
for some time, fueled by
a slowdown in China. Michael Pettis
at China Financial Markets has
been saying the same thing. Indeed, it is analysis
from Pettis that influenced my views in the first place.
Pettis now believes commodity prices will collapse by as much as 50% over the next few years. His rationale
is solid.
Here are a few snips from a recent Michael Pettis email in which he outlines
the case.
By 2015 Hard Commodity Prices Will Collapse
For the past two years, as regular readers know, I have been bearish
on hard commodities. Prices may
have dropped substantially
from their peaks during this time, but I don’t think the bear market is over. I think we still have a very
long way to go.
There are four reasons why
I expect prices to drop a
lot more. First, during
the last decade commodity
producers were caught by surprise by the surge
in demand. Their belated response was to ramp up production dramatically, but since there is a long lead-time between intention and supply,
for the next several years we will
continue to experience rapid
growth in supply. As an aside, in my
many talks to different groups of investors
and boards of directors it has been my impression that commodity producers have been the slowest
at understanding the full
implications of a Chinese rebalancing,
and I would suggest that in many cases they still have not caught on.
Second, almost all the increase
in demand in the past twenty years, which in practice occurred mostly in the past decade, can be
explained as the consequence
of the incredibly unbalanced
growth process in China. But as even the most
exuberant of China bulls now
recognize, China’s economic growth is slowing and I expect it to decline a lot more in the next
few years.
Third, and more importantly,
as China’s economy rebalances towards a much more sustainable form of growth, this will automatically
make Chinese growth much less
commodity intensive. It doesn’t matter
whether you agree or disagree with my expectations of further economic slowing. Even if China is miraculously
able to regain growth rates of 10-11% annually, a rebalancing economy will demand much less
in the way of hard commodities.
And fourth, surging Chinese hard commodity purchases in the past few years supplied not just growing domestic needs but also rapidly growing inventory. The result is
that inventory levels in China are much too high to support what growth in demand there will be
over the next few years,
and I expect Chinese in some cases to be net sellers, not net buyers, of a number of commodities.
This combination of factors
– rising supply, dropping demand, and lots of inventory to work off –
all but guarantee that
the prices of hard commodities
will collapse. I expect
that certain commodities,
like copper, will drop by 50% or more in the next
two to three years.
Based on my many trips in recent years to places like Australia, Peru and Brazil, I had plenty of anecdotal reasons to believe that commodity producers had significantly overestimated the
sustainability of the Chinese
growth model (or, perhaps
more accurately, had not really thought about whether or not it was sustainable). I was worried
that they were expanding production very quickly. Everywhere I went
I heard stories of large-scale
investments to expand
production.
Many producers have acknowledged recent price declines, but they seem to believe that these are likely to be short-lived and that prices will
soon rebound when Chinese demand returns. For example the Financial Times’ Alphaville
quotes Nev Power, chief executive of Fortescue Metals, discussing iron ore at a recent meeting:
Iron ore prices have slumped to $US104 a tonne in recent
days, yet Mr Power said it could
soon rebound as high as
$US150. ”As soon as restocking
and production returns to normal we expect to see prices back in the $US120
to $US150 per tonne range,” he said.
He will almost certainly be wrong.
Production capacity has grown
The surge in Chinese demand at the beginning of the last decade consequently caught everyone by surprise. Minack
shows, for example, that
in the past twenty years, global demand for steel grew by roughly 6% a year, with most
of that coming in the past decade. If you exclude China, however, global demand for steel grew by only 2% a year in the past twenty years,
implying that China accounted for almost all the increase in global demand in
the last twenty years
– and almost all of that
occurred in the past decade. In the past
ten years Chinese demand for iron ore has grown by 16% a year on average.
The initial surge in demand
caught commodity producers off-guard. Because they
were unable to ramp up production quickly enough, prices surged. After
a few years of high prices,
however, commodity producers responded to the huge new increase in demand by planning major expansions in production facilities.
What about demand?
China currently is the leading consumer of a wide variety of commodities wholly disproportionate to its share of global GDP. The country represents
roughly 11% of global GDP if you
accept the stated numbers, and substantially less if you believe,
as I do, that growth has
been overstated because
of the difference over many
years between reported investment, i.e. its input value, and the actual
economic value of output. China nonetheless accounts
for between 30% and 40% of total global demand for commodities like copper and nearly 60% of total global demand
for commodities like cement and iron ore.
The only reason China has
provided such an extraordinarily disproportionate
share of global demand
for hard commodities has been the nature of China’s growth model. While China may
represent only 11% or less of the global economy, it represents a far, far greater share of the world’s building of bridges, railroad
lines, subway systems, skyscrapers, port facilities, dams, shipbuilding facilities, highways, and so on.
Over the next decade, two things are going to change. The first is
increasingly recognized,
and that is that Chinese growth rates will drop sharply. The second is
that China will rebalance its economic growth away from its
appetite for commodities.
Which Way Can Prices Go?
For these reasons I am very pessimistic
about hard commodity prices
and expect them to drop substantially further in the next two to three
years.
1. Production capacity for hard commodities is rising much too
quickly, in a belated response to the unexpected surge in demand just under a decade ago.
2. Expected economic
growth rates in the country that
has been biggest source of new demand
– virtually the only
source – have fallen sharply
and commodity prices have
fallen with them. Historical
precedents and the arithmetic
of rebalancing suggest, however, that the current consensus for medium-term
Chinese growth is still too
optimistic. Expected
growth rates will almost certainly fall further in the next two years.
3. Beijing has finally become serious about rebalancing China’s economy, and rebalancing means shifting Chinese growth away from being
disproportionately commodity
intensive. Instead
of representing 30-60% of global demand for most hard commodities, Chinese demand will shift to a more
“normal” level. Remember that
even a very limited shift – from 50%
of global demand, for example,
to a still high 40% of global demand
– represents a sharp drop in global demand.
4. There has been so much
stockpiling of commodities
and finished goods with implicit commodity content in China that
the country could well become a net seller, and not net
a buyer, of a wide variety of commodities in the next few years.
This is going to come as
a shock to many people. In my discussions with
senior officials in the commodity
sectors in Brazil, Australia, Peru, Chile and even Indonesia, it seems to me that many analysts
have been insufficiently skeptical
about the Chinese growth
model and are unaware of how dramatically
the consensus has changed in the past two years.
They have failed to understand how deep China’s structural problems
are and how worried Beijing has become
(this worry may be best exemplified
by the extraordinary growth
in flight capital from China since
early 2010).
Under these conditions I don’t
see how we can avoid a very
nasty two or three years ahead
for commodity producers. This isn’t all bad news, of course. What will be a disaster
for hard commodity producers
will be great news for companies and
countries that are commodity
users or importers. One way or the other,
however, we are going see a
big change in the distribution of winners and
losers.
Given that iron ore prices have already fallen by more than 50% perhaps iron does not see another 50% decline. Regardless, there is certainly
room for many commodities
to plunge that much, and copper is a prime example.
The price of copper at the beginning of 2005 was $1.50 and it fell below that
price in late 2008 and early 2009.
Pray tell why can't (and shouldn't) copper see that
price again if Pettis' view of Chinese growth is accurate (and I am quite confident in his view).
Official Denial from Australia Prime Minister
Please consider an
official denial regarding
Australia's mining sector : Boom Isn't Over Says
Prime Minister
AUSTRALIA'S mining boom is not over and its 'death' has been exaggerated according to Prime Minister
Julia Gillard.
Ms Gillard said she understood there was growing
uncertainty due to economic
problems in Europe and America,
rising competition and a softening of China’s growth.
"Let’s be clear," she said, "reports of the mining
boom's death are exaggerated."
Ms Gillard said the boom had three distinct phases - a prices boom, which was passing; an investment
boom, yet to reach its peak, and a production boom
"as all that effort comes
to fruition in the years and decades
ahead".
Her comments come as iron ore prices drop and Australia's third largest iron ore producer, Fortescue Metals
Group, today added its name to the list of companies pulling back expansion plans.
Question? What
Question?
“There is no question about whether we have a boom, the issue is whether we make
it last” said
Prime Minister Gillard.
Note the sheer foolishness
of Gillard's statement.
It is not up to Australia
at all whether the boom is over or not. The boom is entirely dependent on what China does or doesn't do.
Moreover, there is no question the boom is over.
The real question is "How big is the bust?"
Read more at http://globaleconomicanalysis.blogspot.be/2012/09/by-2015-hard-commodity-prices-will.html#DT0bXbRHq5rcShEu.99
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