Commodity Boom?????? Reports continue to hit the market concerning booming economic growth in China and India. That the commodity boom will be with us for… … years to come and that prices paid for primary input commodities will continue to soar.
It is agreed that demand for infrastructure works in these countries will continue to support these markets, however, there has to be time when passing on price increases is just unrealistic.

As a consequence of the current price regime, we believe we have just entered into a period of consolidation for primary input commodities such as Oil and Base Metals. WHY?

When you scratch out the current state of the global economy you start to realise the following:

The cost of money in the US has risen 475% in the past eighteen months and confirmation from Bernanke and other Federal Reserve Presidents suggest that inflation remains a concern. US rates will continue to move higher.
The cost of primary inputs has also risen by around 200% in the same period.
Personal savings rates in US remain at zero or close to negative.
There is no real easing of Personal consumption rates which continue to remain fixed at the higher end of the range (see below).

Given this “scratch” analysis the prospects for further gains in these commodities for the time being must be looking limited. In reality, would manufactures be happy to continually see profit margins eaten up by expensive inputs? Would consumers be happy to continue to consume if prices keep increasing?
China has just put its foot down on expensive imports of iron ore. Last year they had to pay a 75% price increase and now this year they have just rejected a further 19% increase by BHP and Rio Tinto. As they are a major importer of iron ore and as steel production is running at a surplus in China, then in reality why should they pay up on the new prices? Perhaps we shall see more examples of this in the not to distant future in other base metals contracts.

On Oil, obviously we need to stand vigilant over any geopolitical concerns, however, both suppliers and users have noted that prices over US75.00, serves nobody any good. In all, purchases and price increases of these primary input commodities need to be economically justified and either absorbed or passed on.

So why do we suggest a high?

Over the last twelve months we have seen manufacturers opting not to pass price increases on to the consumer, rather preferring to keep market share for their product. Maintaining market share these days is the most important aspect to maintaining profits in the long run. However, as prices increase, profit margins decrease and it is only a question of time before these manufacturers have no choice but to move prices higher.

Talking to several local manufacturers, it appears that we are just at the point when price increases have been instigated. If we follow this line of rhetoric globally then the arguments for inflation continuing to edge higher, remain just as solid as they did when the Federal Reserve first started to move on rates. In fact, as we can see from the chart below we believe consumers still remain geared to spending, a concern, given that manufacturers are moving prices higher.

As can be seen from the chart below we remain at the lower end of the scale over the last 15 years and as we suspect CPI less Food and Energy looks set to test higher.

We could in reality be mid stream in the global interest rate tightening cycle if consumers maintain current spending patterns.

As rates continue to move higher traditional economic thought suggests that a dampening effect will emerge.
The current situation is not new and we would anticipate that as rates continue to march higher, economic growth will stall and therefore demand for these primary input commodities will ease. The longer input commodities remain high, the longer the interest rates have to remain high.

The Federal Reserve has to balance increasing rates with sustaining economic growth and controlling the deficit.

One important aspect of higher rates is that you have a good base to start easing when it it is needed.

So given that we see a consolidation period under way how far can prices retreat?

Oil
As can be seen for the chart below Oil is trading at in a volatile manner .We continue to support the fact that given we have no new geopolitical concerns, that Oil between US 70.00 and 75.00 is expensive. We would be looking at 10-15% correction from current levels. All the recent data and comments concerning daily surpluses, inventory builds in the US and OPEC sales, we suggest that Oil would be more comfortable trading in the mid to low US60s. We remain short with stops at US75.30.

Base Metals
All Base Metal markets remain extremely volatile and at these prices we suggest that the volatility will continue. The key for a move lower will be with inventory builds and slower economic growth verses labour disputes and machinery breakdowns. At these current price levels Cu 7875, ZN 3655 and Ni 21400 we would be better sellers on rallies. We believe producers would be looking to lock in these high prices and as interests rates continue to move higher see global growth slow down. Our current expectations are for a further correction of between 10 and 15%.

Gold
Interesting time for Gold! It has corrected 15% from its high of 730 and with the economic picture re focusing on inflation we suggest that Gold is once again looking cheap. At the moment we are seeing weaker prices, however, as inflationary expectations pick up we suggest that gold will have a good bounce from the current level of 625. Target 665 then perhaps 730 again. Stops can be placed below 610.

Important Commodities

Jonathan Barratt BEc| Head of FX and Metals | Tricom FX & Metals
Ph +61 2 8274 6121
Ph 1300 732 288
Fax +61 2 9251 6331
jonathan.barratt@tricom.com.au
http://www.tricom.com.au/