The Economist | Aug 22nd 2008
DURING the six months to the end of June commodities posted their best performance in 35 years, rising by 29%. In July they had their worst month in 28 years, falling by 10%. The slide continues: an index compiled by Reuters, a news agency, shows that prices are almost a fifth below the pinnacle reached in early July. The Economist’s index, which excludes oil, has fallen by over 12%. Breathless headlines have hailed the bursting of a bubble.
But most analysts are more reticent. They cite various reasons for the recent drop in prices, chief among them the darkening economic outlook in rich countries. In recent weeks it has become clear that Europe and Japan are faring even worse than America, and so are likely to consume less oil, steel, cocoa and the like. But that does not necessarily presage a collapse in commodity prices, they argue, thanks to enduringly strong demand from emerging markets such as China.
Oil consumption, for example, has been falling in rich countries for over two years. Goldman Sachs expects them to use 500,000 fewer barrels a day (b/d) this year than last. But it reckons that decline will be more than offset by an increase of 1.3m b/d in emerging markets. It predicts China’s demand for oil will grow by 5%.
A similar story could be told of many commodities. Marius Kloppers, the boss of BHP Billiton, a huge mining firm presenting its results this week, argued that emerging markets were much more important to the firm’s fortunes than rich ones were. Developing countries, he said, consume four to five times more raw materials per unit of output than rich ones do. He predicted that China’s use of steel, already greater than any other country’s, will double by 2015. China’s continuing and rapid industrialisation, he argued, would outweigh any temporary slowdown in exports owing to the weakening world economy—although demand for metals that are used in consumer goods, such as aluminium and nickel, may suffer somewhat.
As Mr Kloppers pointed out, emerging markets, and China in particular, now account for the lion’s share of growth in global demand for raw materials, and a good chunk of overall consumption (see chart). China’s appetite for such goods is growing more slowly than it did in the early part of the decade—when oil consumption galloped ahead by more than 10% a year. And China’s economy has also slowed slightly—although it is still growing at a rate of about 10%. The IMF expects developing countries to grow by almost 7% this year. That should be enough to keep demand for most commodities expanding briskly.
In terms of supply, however, the picture is more mixed. Farmers, encouraged by high prices, have been planting more grain. Heavy rains in America’s farming heartland earlier in the year did less damage to crops than expected. The International Grains Council, an industry group, now expects a record wheat crop this year, 9% bigger than last year’s. China and India, meanwhile, have produced record amounts of soyabeans, while Thailand and Vietnam have harvested bumper crops of rice. Although stocks of most farm commodities remain alarmingly low, and demand continues to grow, the increasing evidence of a strong supply response has helped to push prices down.
The world’s output of industrial metals is also expanding, and prices have been dropping for over a year. But progress has been fitful. At many mines, the quality of the ore is falling as the richest seams are exhausted. Mr Kloppers spoke of BHP’s woeful shortage of tyres for its huge trucks, big mechanical shovels, bearings and all manner of other equipment. Such bottlenecks have been hampering the opening of new mines and the expansion of existing ones. Kona Haque of Macquarie Bank points out that copper mines have produced 1m tonnes or so less than planned in each of the past three years (over 5% of global output), and are likely to do so again this year.
High commodity prices have created something of a vicious circle by adding to the expense and difficulty of expanding output. This week, Xstrata, another big mining firm, suspended operations at a nickel mine in the Dominican Republic while converting its power supply to run on coal, rather than—more expensive—oil. Power shortages have disrupted mining and smelting in several countries. The Chinese government has started to discourage the expansion of energy-intensive industries, including aluminium and steelmaking, in an effort to ease the burden on its grid. All this is hampering the production of metals around the world, and so slowing the fall in prices.
Nonetheless, the output of most metals is still growing much faster than that of oil—which is barely expanding at all. The oil industry, too, is suffering from shortages of equipment and engineers. Even worse, all of the countries best equipped to pump more of the stuff are members of the Organisation of the Petroleum Exporting Countries (OPEC).
Saudi Arabia, the cartel’s biggest producer, has increased its output in recent months, even as the rich economies, still the largest consumers of oil, slowed. That helped to push the price down from $147 a barrel to less than $115. Despite a rise in American inventories, global stocks do not appear to have grown much, suggesting that buoyant developing economies absorbed most of the increase in supply. Meanwhile, more hawkish members of OPEC, such as Venezuela, are calling for a cut in output to stop oil prices falling further. When OPEC last cut production, early in 2007, prices doubled in just over a year.
Other factors also influence commodity prices. Some see commodities in general, and gold in particular, as a hedge against inflation, and so may sell if their fears about rising prices abate. Other investors may sell to cover losses in other markets, or to rebalance their portfolios in light of falling share and bond prices, or to avoid the wrath of America’s politicians, who have vowed to crack down on “speculation”. Commodities also tend to move in the opposite direction to the dollar, which has risen of late. All that notwithstanding, argues Francisco Blanch, of Merrill Lynch, as long as economic growth holds up in the developing world, the price of commodities should too.