Commodity bulls may be rushing towards the precipice
Commodity prices just keep on climbing, but not everyone thinks the rally can last.
Yesterday the price of copper broke through the US$8,000 a tonne barrier to set an all-time high at US$8,150, up an astonishing 50 per cent since the beginning of last month.
It is not just copper.
The prices of zinc and platinum also reached record levels yesterday, while aluminium topped US$3,000 a tonne, its highest since 1988.
Gold breached US$700 an ounce to record a 25-year high, while crude oil continues to trade above US$70 a barrel.
But looking beyond the immediate term, some analysts are beginning to worry that the run-up in commodities markets is acquiring all the signature characteristics of an unsustainable investment boom.
No one doubts that prices should be rising for solid, fundamental reasons. With robust economic growth generating strong demand for industrial metals, especially from China, suppliers are struggling to keep up.
Over the last few months, however, the rally has been increasingly driven by flows of investment dollars rather than by demand for the underlying materials.
Disappointed by poor returns from stock and bond markets, institutional investors, hedge funds and retail investors have all sought to diversify away from straight financial assets and jump on the bull trend in commodities.
According to one estimate, more than US$20 billion was pumped into commodity-linked notes, funds and derivatives last year, and there is no sign of a slowdown so far this year.
According to a report by independent London-based research outfit Capital Economics, this speculative demand is likely to continue to support commodity prices in the near term.
At some point, however, prices will fall, and when they do, position unwinding by financial investors will exacerbate the slide, warns the report's author, Simon Hayley.
Mr Hayley argues that supplies of commodities are more flexible than is generally assumed. He points out that although investment in new mining capacity was subdued during the 1990s, there is no shortage of metals in the ground. He estimates that the world has 32 years' worth of known copper reserves that can be extracted economically at 2005 prices, and 52 years' worth of iron ore.
And those reserves will grow. As prices have risen, mining companies have ramped up exploration spending. Last year they spent more than US$5 billion on non-ferrous metal exploration worldwide, up from US$1.9 billion in 2002.
'The historical precedent is that supply is able to expand to meet demand, and we see no reason to believe that things are fundamentally different this time,' Mr Hayley warns.
At the same time, he expects demand growth to slacken, particularly from China. As Beijing attempts to reorient the economy towards greater domestic consumption, commodity-intensive investment will decline and demand growth should slow sharply.
Any fall in the value of the US dollar will help to support prices, but the impact is likely to be small. Mr Hayley predicts that metals prices will fall 15 per cent between now and the end of the year and drop another 26 per cent next year. He is even more bearish on the price of oil, forecasting that crude oil will fall to US$50 a barrel by the end of the year, down 30 per cent from current levels.