April 21, 2013 5:04 am

The only way is up for commodity prices

Recent falls in prices do not take the long-term dynamics of supply and demand into account

A week can be a long time in commodities.

Last Monday, the gold price suffered its greatest percentage fall in 30 years, as the Cyprus government pushes for the sale of its central bank’s gold reserves. On Tuesday, Brent crude dropped below $100 a barrel for the first time since July last year, while the copper price – a barometer of global industrial health, moved closer to $7,000 a tonne.

These price upheavals were triggered by slightly lower than expected gross domestic product growth in China, reviving fears of further slowdowns in the country’s economy.

Besides these immediate numbers, a growing belief that commodities’ fundamentals have eased has also added to a depressed sentiment, prompting several commentators to announce the end of the decade-long secular uptrend in commodities.

However, these predictions may underestimate the long-term dynamic of supply and demand fundamentals, as well as the impact of the unprecedented monetary policies spreading across the globe.

These factors are likely to maintain global raw materials in an upward cycle that could be as long as those observed from 1900-21 or from 1933-54.

The production adjustments to meet the global needs of the 21st century must continue, and will only be brought into balance by sustained additional increases in the commodity price structure.

We now all understand – as Chatham House, the London-based think tank, reiterated in its December 2012 report – that more than 4bn people in emerging economies currently aspire to western standards of living. The most up-to-date demand curves clearly confirm that this ambition has not been revised downward at all in response to the economic crisis.

The fact is that this “crisis” is primarily of the west and specifically a reflection of the western world’s indebtedness. As non-OECD countries industrialise and urbanise, more people have to be fed, housed, transported and heated, intensifying global competition for non-renewable resources.

As illustrated by oil group BP’s recent statistical review, non-OECD oil demand rose by 13.7m barrels per day from 2000-11, while that of OECD
countries increased by
just 11.7m with that also being over a much longer period from 1970 to 2011.

Despite this increase, the gap between these two worlds is still striking: a resident of the OECD consumes 14 barrels of oil per year, or nearly five times more than in the rest of the world.

Also, a quick look at
the globe is enough to understand that the remaining reserves of energy and minerals are mainly located in geologically challenging and potentially politically unstable areas. One may just remember the tidal wave of the uprisings that has taken place in Arab oil-producing countries since 2010; or the minerals extraction in the Democratic Republic of Congo, where conflicts in the tin-rich Kivu region have led to one of deadliest wars of the past 15 years.

Agricultural production is not immune from such threats: consider the military actions that kicked off in the Ivory Coast, the world’s largest cocoa producer, as a result of the disputed 2010 presidential election.

The production and distribution of commodities is complex, costly and requires high levels of investment and skills; particularly as the sector largely underinvested in capital projects, research and professional training in 1985 to 2000. And just as the industry took the measure of the capital injections needed, the financial crisis struck a huge blow and delayed a number of projects, which explains why supply is still struggling to catch up with demand.

Environmental concerns and regulations have further had an impact on producers’ enthusiasm to invest; in addition, the fiscal insanity of some governments and their undulating compliance with property rights continue, jeopardising long-term project planning.

This means the period of easily available low-cost resources is over. In future, production companies will have to explore more extensively, dig deeper, farm more efficiently and transport materials over much greater distances to supply pent-up demand.

To sustain such higher costs, the price structure of commodities needs to rise further.

Only such an uptrend will allow the generations of the 21st century to lead people and capital toward the production of the raw materials that are essential to our survival and development.

It is clear that some of the biggest innovations are no longer to come in the areas of computing, entertainment and telecoms but in the business of commodity production and transportation.

Stephan Wrobel is chief executive and Marion Megel is a metals analyst at Diapason Commodities Management

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