OZL 0.95% $15.96 oz minerals limited

the outlook for commodities ... excel article

  1. 13,594 Posts.
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    before you read it, it might be worth reflecting on what happened this week

    ni, copper and zi dropped a lot on friday which would have knocked the stuffing out of a few.
    but overall we were up
    copper was up 21%
    nickel was up 43%
    zinc was up 10%
    for the week

    anyway this is a great article. the basic gist of which is that we probably should moderate our expectations

    Greg Peel also says this

    "This is not too much of a problem for the large, diversified mining companies which can simply put projects under temporary "care and maintenance", but it has meant death for start-up juniors and pure-plays."

    Might be worth reflecting on this
    Are we a "start-up junior" or "large diversified mining company?"

    I think we were aiming to take over the mantel left by western mining of mid tier miner.


    Hope Michelmore is not being too bullish on commodities to the point that he going to keep operations going for too long and blow all our cash is my biggest worry.

    Anyway read on... a great article - fair, balanced, insightful



    The Outlook For Commodity Prices
    FN Arena News - October 28 2008

    By Greg Peel

    A quick glance at the following chart will set the scene:



    The Reuters-CRB commodity index tracks prices of a basket of commodities including oil, base and precious metals and agricultural products. The steep fall in the index over the last few months has now brought us back to the low level of 2006.

    2006 was a year that saw the first true correction in the commodities bull market which started around 2002 as China hit the scene. It took a while for the world to wake up to the impact of China's emergence, and for a long time analysts warned that commodity prices had simply run away in madness. But when they failed to come back to average levels analysts then realised the "super-cycle" had begun. The super-cycle did not imply prices would go up forever, only that long term average expectations would need to be shifted higher in order to accommodate the emerging markets of the world, particularly China.

    By late 2005 the world had taken the super-cycle story on board with gusto, and combined with the emergence of various new investment products it became a case of commodities being an asset class all of their own. Speculation began to accelerate, and in 2006 gold hit US$725/oz, copper hit US$4.00/lb and oil hit US$70/bbl. It was bubble territory, and subsequently the market went "pop" and we saw gold back at US$550/oz, copper at US$2.50/lb and oil at US$50/bbl. 2006-07 then became years of consolidation, at least until the US dollar began to fall out of bed in late 2007 as the credit crunch hit.

    We all know what happened next. The world went into a frenzy, shifting money out of bonds, stocks and property and into the inflation-safe haven of direct commodity investment. China continued to consume but analysts started warning of a potential slowdown. Oil shot to almost US$150/bbl despite OPEC constantly warning there was no equivalent increase in demand. Gold hit US$1000/oz as Bear Stearns became the first credit crunch victim.

    This was a much bigger bubble, and it was always set for a much more dramatic burst. The prick came when it became clear the global economy was in trouble, not just the US. The US dollar thus adjusted back from its dramatic fall. Gold went first, then oil, and then all commodity prices collapsed. All that new investment money, often levered tens of times, had to come out of the commodity markets.

    And here we are - back at 2006 levels for the CRB index. The question now is: Have commodity prices fallen far enough?

    There are two influences here. One is the artificial world of debt-financed investments being unwound for cash. The other is the real world of lower global economic growth expectations following the near collapse of the global financial system. The former has served to engender even more fear for the latter, suggesting the fall in commodity prices - and the chart illustrates just how spectacular that has been - has been overdone. If that is the case there should be some recovery rather than more spectacular falls. However, any initial recovery will only be back to levels which rightly reflect the new global economic picture.

    Commodity analysts are always behind the curve. They reluctantly chased spot prices up and up for five years before finally suggesting, in many cases, that prices must continue to spiral upward. Forecasts of US$200/bbl for oil, US$1100/oz for gold and US$6.00/lb for copper were not unusual. As soon as commodity analysts switched from being behind the market to ahead of it, we knew it was all over.

    Now they have to chase the market back down. There is little denying that 2009 economic forecasts paint a bleak picture for commodity prices. This has been the underlying theme of late as commodity analysts move quickly to re-forecast in the new environment. Analysts usually try to only adjust their prices about once a quarter to avoid constant and misleading price shifts. However recently they have quickly jumped in with new predictions, many rather dire.

    FNArena has reported over the last couple of weeks that various broking houses have reset their commodity price forecasts, and thus relevant share price forecasts in the resources sector, in response to the big commodity sell-off. Earlier expectations of ever-increasing prices have now been shot down. If there is a common theme, it is that the rest of 2008 could yet see lower prices as the world comes to terms with slowing economies in the US, Japan, Europe and the emerging markets. However the downside should now be limited given the extent of the falls.

    There will be upside, and most brokers are looking at early 2009 as being a time for commodity prices to recover somewhat. But the days of speculation are gone, and commodity prices will return to reflecting simple demand and supply. The demand side has been shot to pieces by the global financial turmoil.

    Which just leaves the supply side. From 2002 onwards, analysts warned that spot prices could not continue their run upwards given the supply side would respond accordingly. They were actually right, but it just took a lot longer than expected. Years of underinvestment in the sector meant supply responses were slow and beset with delays. As the cost of inputs rose, new supply projects became more marginal. Not helping was a global lack of mining professionals, mine workers, equipment and infrastructure.

    The nature of cycles suggests that new supply will often be brought on line just at the top of the market. The supply side has gone a long way to catching up in 2008, and now commodity prices have collapsed. To top it off, the cost of credit has become prohibitive. Suddenly new supply projects are uncommercial and will need to be shut down. This is not too much of a problem for the large, diversified mining companies which can simply put projects under temporary "care and maintenance", but it has meant death for start-up juniors and pure-plays.

    While the supply side had gone a long way to catching up with the new super-cycle, it hadn't reached oversupply levels by any means. And now a lot of supply will disappear. The result will thus be stabilisation of commodity prices as the global mining industry consolidates. There is a floor under commodity prices.

    Another prevailing theme among analysts is one in which the super-cycle is not over. Were commodity prices to stabilise at current levels they would still be - at least as the CRB index average suggests - only back at 2006 levels. That's still an awful lot higher than turn of the century levels. That is, in a nutshell, the super-cycle. But for commodity prices to begin to really rise again, aside from just bouncing from oversold levels, we will need to see China and other emerging markets recover from the global economic slowdown intact. The big factor here is whether the domestic economies in the likes of China and India can offset what will be years of slow economic growth in the Old World.

    China and India are not about to return to peasant status. Economic growth will slow, but the move towards industrialisation and urbanisation in these massively populated countries will ensure demand growth for commodities for many years to come. The difference will be, nevertheless, that this demand growth will be "real". No longer will leveraged speculators push commodity prices to spectacular levels.

    Which is hardly a bad thing.

    Citi is the latest local shop to take a knife to commodity price forecasts, and subsequently resources stock price targets. Underlying Citi's big shifts down in commodity price expectations is the new global economic environment. Underlying a slashing of resource stock price targets is a response to lower commodity prices and expectation of lower multiples throughout the sector.

    Lower multiples (price/earnings ratios) imply the market is no longer going to be as excited about investment in resources and thus no longer prepared to push share prices to high multiples of earnings forecasts. There is simply not going to be as much money in the market to do so.

    Citi, however, joins other brokers in believing that an ultimate recovery in commodity prices is ahead after an initial slow period. The supply side will be even more constrained than it had been previously and the demand side has not evaporated altogether. The analysts have absolutely slashed some share price targets, but in nearly every case the market has already slashed trading prices more so. The result is that Citi's ratings on resource stocks still lean firmly to the Buy side.

    One element the local market has tended to overlook in the rush to liquidate stock and commodity positions is the 40% fall in the Aussie dollar against the US dollar. While Australian miners and drillers have taken a big hit on commodity prices, in a lot of cases profit forecasts remain relatively stable given the boost from the lower currency.

    Investors looking to jump into the resource sector in the belief commodity prices will quickly run back up to their highs can think again. This will not happen for a long time. But in the bigger picture analysts still see the resource sector as a valuable long term investment. The difference is, aside for a slow year or two ahead, that the resource sector will recover only to become the lumbering giant of bygone days, not the playground of global speculation. Double-digit economic growth in emerging markets now also looks like a feature of bygone days.

 
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