Instability and volatility has characterized the resources industry in recent times as companies grapple with the impact of sustained low commodity prices, delays in the onset of supply discipline and uncertain global growth prospects.
Whilst the current market is not unusual for a cyclical industry such as resources, it does not make the situation any less challenging.
More recently, we have seen an increased level of optimism that has not been present for some time. While there are some positive indications that the market may have found a bottom earlier in 2016, I believe a sustained recovery is not imminent. The key to understanding this market is differentiating between a demand driven and a supply driven market.
Impacts and influences on the current market environment
Throughout the decade to 2011, we saw a demand driven episode which David Jacks describes in his paper, ‘From Boom to Bust’, as an event closely linked to historical episodes of mass industrialization and urbanization which interact with acute capacity constraints[1].
This spike in demand was a catalyst for intense capital investment which eventually saw a supply surplus introduced to the market. This excess supply and slowing global growth in US dollar terms has culminated in heavy impacts on commodity prices. The strengthening US dollar has exacerbated excess supply in domestic dollar terms in commodity driven economies. Slowly, we are seeing signs that a correction across the industry is occurring, where supply and demand are recalibrating, and some commodities have seen limited price recoveries.
Mixed views remain as to when and to what extent the mineral commodity prices may start to recover sufficiently to incentivize idled capacity or even new supply to enter the market. An indicator that I find compelling is the correlation between commodity prices and the growth in global GDP. This point of view suggests that commodity demand is a function of global GDP, rather than solely linked to any single economy (e.g. China) and that as global GDP increase, demand for commodities generally increases over the medium-term. Copper is often used as proxy to demonstrate this effect; with the added advantage that copper is historically sensitive to early stage recovery trends.
[1] David S. Jacks, ‘From Boom to Bust: A Typology of Real Commodity Prices in the Long Run’ Revised March 2014
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Source: IMF data, AME, Bloomberg, RCF analysis, February 2016[2]
[2] Information shown for Copper is used for informational and demonstrative purposes only. Each commodity will be subject to its own facts and circumstances which may make it more or less likely to align with the example provided. This information should not be deemed to be a recommendation of any specific commodity, company or security. This chart includes forward-looking information, and we caution you that such information is inherently less reliable. Actual performance will vary due to a variety of factors, including general economic conditions. Any projections have been prepared and are set out for illustrative purposes only, and do not constitute a forecast. Any projections or opinions are current as of the date hereof only. The statistical information provided herein has been supplied for “informational purposes” only and is not intended to be and does not constitute investment advice. Neither RCF nor any independent third party has independently audited or verified this information. RCF disclaims any and all liability relating to such information, and no representation or warranty is made, expressed or implied, as to the accuracy or completeness of the information provided in this presentation.
Following the copper growth trend line
While China’s impact and influence on commodity markets is certainly significant, RCF takes a more holistic global view of supply and demand trends. Generally, what the relationship between global copper and GDP growth demonstrates is that mine supply and nominal commodity prices rise over time, and must do so if demand is to be satisfied.
The China growth story is likely to continue yet perhaps not at the rates we have witnessed previously and it is also likely that price volatility will continue. Recent, long dated research by Paul Gait at Bernstein highlights that, ‘As the lead times and technical and social complexity of delivering the incremental unit of supply increase, we expect to see a continuation of the high levels of price volatility seen recently’[3].
We agree with this view and feel that commodity prices are going to experience higher levels of volatility in the next 1 to 2 years. The industry is still in a period where demand and supply imbalances are adjusting, however, it is important to note that this is a supply-driven bear market; it will not trade like a demand-driven market. In the current market, demand hasn’t really changed, only its rate of change has decelerated. For prices to sustainably rise for current levels, it will take lower prices to push and keep supply below current demand levels, which are growing but more slowly than in the past, to create a deficit. As a result, higher prices are not likely to be sustainable in the near-term because supply, in the form of excess capacity, is primed to return with higher prices. It is likely that we will experience a number of false starts before demand eventually overtakes existing supply capacity, which will mark the starting point of the next sustained upcycle.
[3] Bernstein: Gait, Floris and Absolon, ‘European Metals & Mining: Boom and Bust and Back Again, 246 Years of Copper Price Cycles’ January 19, 2016
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