Are Commodities in Bubble Territory?

2 mins read

Major base prices up sharply

Commodities have been in a strong bull run since 2002 with all the major base metal prices up considerably over the period as illustrated below :
Copper +375%
Lead +260%
Nickel +135%
Zinc +131%
Aluminum +115%

Demand from emerging markets such as the BRIC countries of Brazil, Russia, India and China has been driving this phenomenal increase in the price of base metals as they seek to rapidly industrialize their economies to become developed countries. Also, the Gulf States of UAE, Saudi Arabia, Kuwait, Oman and Bahrain are using oil surpluses to develop their infrastructure to diversify their economies into other areas such as tourism, technology and the entertainment industry.

Demand for base metals is also being driven by the improving standards of living by the citizens of emerging countries as they join the middle class. As their annual incomes rise, they are buying more household appliances as well as luxury goods such as electronic equipment, cars and boats.

Another important catalyst for price inflation in base metals is the current weakness of the US dollar. The Federal Reserve Bank has cut interest rates from 5.25% last September to 2% at present. This is well below the inflation rate of 4% in the USA. Also to try to avoid a recession, the Federal Reserve Bank has been injecting significant amounts of liquidity to bail out the banking system which is deteriorating significantly due to having worthless subprime mortgage bonds on their balance sheets. This unlimited generation of US dollars is creating inflation which in turn is motivating people to hold tangible assets to protect them from the devaluation of the greenback.

A third reason is that a global mining boom has raised prices for drilling equipment and contractors at a time of record fuel costs. In addition, there is a lack of skilled labour and geologists which is driving up salaries. Supply is also being impacted by environmental concerns and it is now much harder to acquire the necessary permits to develop a mine than a decade ago.

The development cost of the largest mine in the world, BHP Billiton’s Olympic Dam may rise threefold according to estimates by JP Morgan. Newmont Mining Corporation, a large gold miner said that cost of developing its Boddington mine in Australia may increase by 78 percent to $1.6 bln due to higher wages and equipment prices. Last November Teck Cominco Ltd. and Novagold Resources Inc. halted development of the Galore Creek copper and gold mine in Canada after the estimated cost doubled to $5 bln.

One should not however invest indiscriminately into all base metals. For the short to medium term, investors should look at metals such as iron ore, coal and copper to take advantage of emerging countries’ rollout of infrastructure and construction due to the high demand for steel and electrical generation. In the longer term, as standards of living improve, other metals such as aluminum, plus lead which is used in batteries, plus cobalt – used in electronics will be more in demand.

During a briefing hosted last week in London, Rio Tinto’s chief executive Tom Albanese said that the company is well placed to take advantage of an expected doubling in global demand for its metals and minerals by 2022. Such statements inspire confidence that the bull market in base metals still has some way to go and is sustainable.

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Hollingsworth International Financial Services Ltd is licensed by the Malta Financial Services Authority to provide investment services under the Investment Services Act 1994.