Bulls beware as studies show commodity prices set to fall
Investors buying into commodity markets or resource stocks in the belief that rising demand from China will push prices higher should take care. Two authoritative studies published yesterday both warn that commodity prices are likely to fall.
Over the past few years, ordinary investors have poured money into commodity markets and have enjoyed spectacular returns. Since late 2001, the price of crude oil has more than tripled. Copper is up sixfold.
Despite a recent sell-off that has seen prices retreat from May's all-time highs, the bulls are undismayed. Mounting demand for energy, metals and soft commodities from rapidly developing Asian economies, especially China, can only push prices higher over the long term, they argue.
Certainly China has recently developed a prodigious appetite for raw materials. According to BP, China's consumption of oil rose 50 per cent between 2000 and 2005, accounting for a third of the total increase in world demand.
The growth of China's demand for other resources has been even more impressive. According to the International Monetary Fund, the mainland was responsible for roughly half of the rise in the world's consumption of aluminium, copper and steel between 2002 and 2005, and almost all of the increase in demand for lead, nickel, tin and zinc. With its tyre production rising at 20 per cent a year, the mainland became the world's largest consumer of natural rubber way back in 2001.
Commodity bulls believe this appetite is only going to grow. They typically cite the 'S-curve' theory, which looks at the past industrialisation of economies such as Japan and South Korea, and argues that once a developing country's average income per capita exceeds US$5,000 in purchasing power parity terms, its demand for raw materials begins to rise exponentially.
With PPP-adjusted income per head on the mainland now around US$6,000, China has only just entered this range and discovered its hunger for resources. Today the average Chinese consumes just five kilograms of aluminium a year. His American counterpart gets through 20 kilograms.
Unfortunately for the true believers in the commodity bull market, rising demand will not necessarily mean rising prices.
In their latest economic forecasts, both the Asian Development Bank and the IMF have published the results of studies modelling the outlook for commodity markets. Both conclude prices are likely to fall.
The ADB focuses on oil. It assumes that Asian and world growth continues along their current trajectory, that inflation remains constant, that new reserves of oil are discovered at the same rate as in recent years and that there is an increase in energy efficiency of 1.25 per cent a year.
If so, the bank's model shows that oil prices are out of line with their fundamental equilibrium level and predicts they will decline almost 20 per cent from last year's levels by 2015, in inflation-adjusted terms (see chart).
Imaginative policy measures could reduce prices even further. If Asian governments were to scrap all their fuel subsidies and impose taxes at just one-third the level of the European Union, the resulting gains in energy efficiency would drive oil prices down by a further 13 per cent, the ADB calculates.
The IMF, meanwhile, applies its model to non-fuel commodities and especially metals. It concludes that although demand for non-ferrous metals will continue to grow rapidly, new supplies entering the market will more than compensate. By 2010, it predicts the aluminium price will have dropped by 35 per cent, and copper by 57 per cent in inflation-adjusted terms.
If the models prove accurate it will be bad news for the bulls who have pumped tens of billions of US dollars into commodity markets in recent years. On the other hand, falling oil and metal prices will come as a huge relief to mainland companies that have seen their margins eroded to wafer-thin levels by rising energy and raw material costs.