Perverse as it may seem, the further prices fall, the greater the potential for an eventual rise. All metal prices have come down dramatically this year and in the last month in particular. Since this time last year, copper has dropped nearly 30%, zinc over 45%, nickel some 50% and lead 55%, not accounting for a peak in between. There has been no new high grade ore finds in recent years. New investments have been justified largely on the basis of improved technology being able to extract efficiently from lower grades along with higher metal prices justifying the mind boggling investments required.
Producers in some metals are now operating at or below cost. Aluminum smelting falls into this category as does nickel production and many lead-zinc mines. This in itself does not push up prices but unlike copper which is still above the marginal cost of production, it does force producers to make a painful choice at current price levels – produce and sell at a loss or idle production capacity. Falling demand also has that effect but as we have seen with rising LME stocks – when you have a futures market you can (for a time) still produce and deliver to stock even if end-user demand is not there.
Our belief is the current low (compared to the cost of production) prices will encourage producers to idle capacity during 2009. We have already seen many new projects postponed or cancelled altogether due to credit related issues and some posturing among producers regarding production cut backs. This process will continue as demand remains weak and prices remain low, particularly if energy costs do not follow the wider commodity markets lower. The faster and more dramatic that process is the quicker the markets will get back into supply balance and the steeper the price increases will be when demand does eventually improve (probably in late 2009 and 2010). Significant production closures would reduce the supply base and make a supply shortage that much more acute when demand gradually returns.
Meanwhile we see the euphoria of early this week as a blip not a return to the Bull Run. Prices will stay (with some volatility) flat for the next 6 months as everyone, speculative investors included, seek to better understand what the next year or so holds.