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Investors who thought the so-called commodity super-cycle fuelled by growing demand from China and other emerging economies would insulate them from the current financial meltdown have received a harsh wake-up call over the past few weeks. Prices for just about everything from base metals and lumber to grains and uranium have all fallen dramatically along with the stock of the companies that produce them. That’s a dramatic shift from the past five years, when bets on the commodity market seemed like a sure thing, and the only question many investors were asking was just how high prices could go?
Despite the recent carnage and the threat of global recession, the long-term fundamentals for many commodities remain well-supported and could rebound, predict analysts and market watchers. But investors have to have patience and fortitude. “We are certainly in the midst of a pretty dramatic correction,” says Bart Melek, Global Commodity Strategist at BMO Capital Markets. “But we’re not going to see a permanent bust.”
China has shown it is not immune to the current crisis. In October, executives at London-based Rio Tinto PLC and Australian-based BHP Billiton — two of the world’s largest base-metal producers — warned that Chinese demand was softening as the Asian economy cooled. China’s GDP rose 9% in the third quarter, less than was expected, and down from 10.1% in the previous one. But even with that slower growth, China should act as a backstop for many commodity prices, Melek says. “Industrial production in China is up more than 15% this year. That’s hardly a recession.”
Still, it’s easy to see why so many investors have fled commodity markets. In late October, copper had dropped from an average price in 2007 of nearly US$3.25 per pound to about US$1.94. Nickel had gone from about US$16.80 a pound to about US$4.50. And zinc had sunk to 50¢US a pound, down from nearly US$1.50 a year ago. Even companies that produce commodities that did not see a precipitous fall in prices could not escape the current meltdown. The price of potash, a vital ingredient in the production of fertilizer that does not trade on the open market, actually increased in September. That didn’t stop the stock of fertilizer producers such as Saskatchewan-based Potash Corp. (TSX: POT) and Calgary-based Agrium Inc. (TSX: AGU) from losing about two-thirds of their value during the recent rout.
Some companies are already cutting production amid the decline in prices. In October, Toronto-based FNX Mining Co. Ltd. (TSX: FNX) announced it would suspend commercial nickel production at its Levack mine near Sudbury, and North American Palladium Ltd. (TSX: PDL) said it would close its Lac des Iles mine near Thunder Bay.
The uncertainty will likely keep metals weak for at least the next year, says Patricia Mohr, vice-president of economics at the Bank of Nova Scotia. “We could see some minor rallies in copper and nickel prices as demand in China rises once more,” she adds, “but we won’t likely see a major rebound until the next decade.” Those sentiments were echoed by Brian MacArthur, an analyst at Toronto-based UBS Securities Canada Inc. In October, MacArthur cut his outlook for industrial metals and material prices by 30% for 2009 and 26% for 2010.
Ironically, the current economic turmoil could end up sending metal prices to new heights, according to a recent report by Virtual Metals Research & Consulting Ltd. Low commodity prices and scarce financing could put new mining projects in jeopardy, which, in turn, will reduce supplies, predicts the London-based commodity analysts. “A recession-induced cutback in supply [could run] slap bang into a resurgence of western world demand and an extension of the prospects for prolonged Asian growth,” they said in a recent report for Fortis Bank.
When that recovery in western world demand will occur is still anyone’s guess — especially given current conditions. And if the economic downturn is as severe as some fear, commodity investors may end up needing the patience of Job.
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