I won’t pretend that there aren’t times when the global metals markets perplex me. Take the last couple of months. The US has clearly been heading for a recession, mild or strong remains to be seen but certainly it’s going to get worse before it gets better. Europe or at least southern Europe is looking decidedly sick. That once famous construction led boom [bubble] does appear to be just that. And the economies of the Club Med region and Ireland are all showing signs of strain. The UK will not be far behind as a combination of rising tax levels and falling property prices takes their toll on consumer spending. Lastly Japan is on the brink of a recession as the rise of the yen chokes off whatever mild growth manifested itself last year. Only the BRIC countries are showing robust growth fuelled by rising living standards, young demographics and generally sound economic management (I’ll stay off my soap box on that one, so far so good). Yet, and here is the source of my frustration ” contrary to the sound logic of supply and demand, the metals markets, instead of a steady easing of prices as demand in the major economies slows, have been rising strongly during February when common sense suggests global growth will be much lower in 2008 than it was in 2007. It reminds me of one of those ore trains with an engine at both ends; one pushing, one pulling. In this case the engine of supply/demand fundamentals has decoupled and the only driver of the train is speculative.
So you can imagine my interest this week to come across Gary Shilling’s article in Forbes painting a picture of an imminent commodities meltdown. (My word not his) One of the major planks of the article is that the current commodity prices are underpinned not by my much loved fundamentals but by commodity investment funds driven by a) disillusionment with shares and property investments and b) a belief that the rising middle class in China and India is fuelling an unstoppable consumer led boom. These funds have been piling onto the commodity markets, sometimes directly, but more often by way of investment vehicles called ETF’s Exchange Traded Funds. This is speculative hot money that can as readily flow back out again if the market looks like it may not continue to generate the returns ” i.e. it goes into decline! Though some of the long term fundamentals are sound, (there is a growing middle class in developing countries and they will continue to industrialize for a decade or more placing robust growth demands on the world’s resources) the short term situation is not so rosy. Demand in two of the four largest trading blocks ” North America and Japan are either in recession or have a strong potential to go into recession during the first half of this year. Europe will at best have flat growth as the more robust northern countries are counterbalanced by the declining southern countries, and they will all be held back by a strong Euro and high ECB interest rates. With such a major chunk of the world economy slowing down, Shilling’s argument is how can China and India keep demand growth sufficiently high to justify the price levels we see today?
Although I would take issue with a few of the points made, on balance I agree there appears no sense in current prices. But for the time being the commodity markets will continue to be pushed ever higher by massive inflows of money from investors looking for opportunities to counter rising inflation and falling equity and property markets. So we are moving from a phase of prices being driven by some sound fundamentals to a phase were prices are driven by unsound speculation.
Let’s hope the driver has some brakes, and knows how to use them. This has the makings of a runaway train.