The Economist: The magnetism of metals

The magnetism of metals
Oct 11th 2004 From

The Economist Global Agenda

Oil is not the only commodity soaring in price. So, too, are base metals such as copper, aluminium and lead

IT IS not just the price of oil that is scaling fresh heights. Base metals are close to, or breaking, new records too. The Economist’s metals index, which tracks the prices of copper, lead, zinc, tin, aluminium and nickel, has risen to its highest level in nearly ten years. The prices of some metals have hit all-time highs lately.

Fuelled by China’s seemingly insatiable demand for raw materials and by investors’ desire for an easy profit, the price of copper is within sight of a 16-year high. Nickel is close to its January peak, which was also a 16-year record. And, at double its average level for the past ten years, the price of lead is higher than it has ever been. Unsurprisingly perhaps, the Reuters CRB index, which combines oil, metals and other commodities, has hit a 23-year high.

Some increases are easy to understand: given a shortage of supply and rampant demand, the price of anything can only go up. But how to explain aluminium’s inexorable rise? Last week, the metal reached its highest price for nine years, despite the fact that there was a stockpile of the stuff overhanging the London Metal Exchange. What is going on?

The easy answer is that, after years of under-investment by producers, particularly during the technology boom of the 1990s when most investors considered base metals dirt, the world has finally woken up to the fact that there are not enough raw materials to go round. With China’s economy growing like topsy—last year, its GDP expanded by 9.1%, and this year it is expected to grow by only slightly less—base metals are in demand as never before. In 2003, for example, China’s imports of copper jumped by 15% and those of nickel more than doubled. Until a couple of years ago, America was the world’s biggest consumer of copper, used in electrical wiring and the like. That changed in 2002 when, for the first time, China consumed more than America. Last year, China extended its lead by devouring 35% more than America.

China’s headlong growth has not only caused acute shortages of metals like copper and nickel (which is used, among other things, to make stainless steel and even types of glass). It has also increased the market’s sensitivity to upsets which during times of plenty would barely cause the price to flicker. Last week, the mere mention of a strike by workers at Codelco Norte, Chile’s state-owned mining group and the world’s largest producer of copper, caused prices to surge even higher because of fears that supplies would become shorter still.

Nickel has been in short supply for the past couple of years. The International Nickel Study Group, which represents producing countries, reckons that supply should come more into line with demand next year. So prices for delivery of nickel from 2005 may begin to soften. That is unlikely to be the case with aluminium and zinc, supplies of which could become scarcer still before they get better.

In the case of aluminium, this is partly because of industrial unrest in North America, which is threatening to disrupt supplies from at least two plants, one in the United States and the other in Canada. It is partly also because demand from manufacturers shows no signs of easing. Ingrid Sternby, a metals analyst at Barclays Capital, believes that the price of aluminium is likely to remain high for at least the next few years. “Even though car production and sales are slowing, there are other segments of the transport sector, like trucks and trailers, which are very strong,” she told Reuters news agency.

During previous booms in commodity prices, as in the 1980s, central banks jacked up interest rates in order to choke off demand and so stifle inflation. This time, argues Alan Williamson, a metals analyst with HSBC, things are likely to be different. There is, he says, more spare industrial capacity around the world than during previous metals booms, thanks partly to China’s rapid growth as an industrial power. The result is that the prices of base metals may stay higher for longer.

It is hard to predict the extent to which new mines and production facilities will come on stream because of higher prices and so increase the supply of metals, or how long it will take for that to happen. Many such facilities are small, and probably wouldn’t be viable at lower prices. Yet, taken together, they could add enough capacity to have a rapid effect on the market, says Mr Williamson.

Harder still to predict is the reaction of investors. Spotting what they saw to be a sure thing, many piled into the metals markets during the summer, in the hope of chasing prices higher still. In that they have been mostly successful. How much higher can prices go? Here, investors are split. Some think that worsening imbalances between supply and demand, as with aluminium and zinc, are likely to drive prices higher still. Others are convinced that some metals are poised for a fall. Indeed, as one analyst put it, the words “lemmings and cliff” come to mind.