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by Scott B. MacDonald


NEW YORK (KWR) On October 28, China announced it was raising interest rates for the first time in nine years. The message from some analysts was that China’s dynamic 9%+ real GDP growth is over and, with that, so is the demand for industrial inputs such as oil, coal, steel and copper. They believe commodity prices will now decline, including oil, which could fall sharply back into the $30s. We are not so certain: we could see oil heading lower by year-end, but chances are that commodity prices are going to stay high for the foreseeable future.

The reasons we are likely to see sustained high prices in many commodities are both structural and geo-political. Oil and natural gas prices climbed because of the short-term fear that access to supply would be reduced by geopolitical events emanating from Nigeria, Norway, Iraq, and Venezuela. Shoot-outs with al-Qaeda-linked radicals in Saudi Arabia did not help matters. On a structural basis, there is greater demand from China and India, not to mention higher demand from more traditional markets in Europe, Japan and North America, owing to economic recovery. We would add that a number of speculators helped to push oil prices up, taking advantage of the fear factor. And, gradually seeping into oil market concerns is that this form of energy is ultimately finite and that the global economy is dependent on fields that are beginning to peak.

As for many other commodities, limited supply is a factor. Prior to 2003, most mining companies were careful not to build up supply, having been hurt by large inventories in coal, copper, nickel and zinc during the late 1990s and early 2000s. Because many companies were careful in moving too fast to bring on capacity, both in terms of the actual resources as well as the processing and other facilities needed to bring them to market, supply for a number of commodities, from coal to uranium is tight. Indeed, copper stockpiles monitored by the London Metals Exchange are at a 14-year low.

In addition, rails and ports in countries like the United States, Canada and South Africa are already running at capacity, making it more difficult for greater supply to make it to end users, hence contributing to the tightness in supply for key commodities. As Con Fauconnier, the head of South Africa’s Chamber of Mines stated (November 2): “Transport infrastructural shortcomings in our country make it impossible, most certainly right now and in the immediate future, to meet not only the demand from China but also a number of other potentially profitable commodity export destinations.”

In the past, energy spikes have been followed by economic slowdowns, usually recessions. This time, however, we have different structural factors at work that are likely to moderate the downturn – namely China’s slowdown is not going to radically reduce its need for commodities. China is suffering from power shortages and will still require high levels of oil, gas and coal imports. There is also a political element: for China to control the current trends of rising public discontent with the widening gap between new rich and poor and official corruption, the government needs to maintain a relatively strong pace of growth. For China to have some level of economic growth, it must have inputs. It is as simple as that.

Although China has signaled that it is taking further measures to reduce the pace of its economic growth, the action of that country’s central bank is not a magic wand that will suddenly bring oil prices and other commodities to more sane numbers. We think that China’s growth will cool, though it will be a soft landing, probably in the 7-8% growth range. At the same time, higher oil prices will moderate global growth in 2005. We see U.S. real GDP growth in the 2.5-3.0% range.

One last factor to consider is the weather. A number of powerful hurricanes recently interrupted oil and gas production in the Gulf of Mexico, which accounts for around 20% of U.S. supply. According to weather data, the hurricane seasons for the next several years are likely to be more severe as part of a long-term cycle. Considering the recent battering from these hurricanes, it is likely that the pattern will be repeated in some capacity through 2005 and 2006.

Short of a global depression in which China, India and all other rapidly industrializing countries collapse and revert to a pre-industrializing state, it is hard to see global commodity prices collapsing in the future. Prices for oil, gas, coal and copper are likely to moderate, but we see no major decline as occurred in the late 1990s and early part of this decade, even with slower global growth forecast in 2005.