An interesting article was published last week in Newsweek by Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management ” in case you were about to dismiss the following as uninformed guesswork. We would suggest anyone interested should read the whole article but in brief what Sharma is saying is that what we have seen over the last few years as a bull market in metal and commodity prices (and the crash of the last six months) is simply the same repetitive boom/bust cycle that has characterized commodities for the last 100+ years. Drawing on several historical examples the article explains how commodities typically go through short bull markets followed by long bear markets. For oil these have been 4-9 years of bull followed by 11-27 years of bear, and that there is nothing new about the recent boom and crash to say that this breaks the mold.
The basis for a widespread belief that the current crash just marks a pause in an otherwise bull market that will run and run, that this time it is different (heard that one before?), is that the emerging markets industrialization will continue in a linear fashion and that the vast quantities of commodities China in particular has been sucking in will continue to rise in the same fashion. What Sharma illustrates is that as economies industrialize they become more efficient at consuming metals and energy, and in so doing the rate of consumption drops off. He also makes the point we have repeatedly come back to in MetalMiner which is much of China’s growth is export lead, and that Europe, Japan and North America, the main export markets, are in a recession which will be followed by a long period of low growth rates. Borrowing had got to unsustainable levels in the west and personal, state and even some corporate debt has to return to more manageable levels if the long term health of those economies is to be assured. Hopefully consumers will not take up the cheap credit being thrown at them to return to a buying binge because that situation was not sustainable in the long run. If those export markets are not buying at previous levels exports will remain depressed.
Drawing on history, Sharma says commodity prices tend to surge only during the mature stages of a boom when the global economy overheats and demand briefly exceeds supply. At the moment, supply for nearly all commodities far outweighs demand, and demand will likely decline for at least the next couple of years. By way of illustration he points to the steel industry that is making short term cuts in mill outputs rather than closing mills. They are clearly hoping the days of 97% capacity utilization will come back in the near future. If they don’t close capacity, supply will continue to exceed demand for many years weakening the mills economic health and pricing power.
Moving on to China the article argues that the country suffers from an over-investment problem. It has been investing at a rate equal to 40 percent of GDP for nearly a decade, a level unprecedented in the history of economic development. Much of the money goes to export industries, which are sagging in the global downturn. Investment demand is not likely to revive soon, nor should it. China contributes 10 percent of global economic output, but has been consuming 25 to 50 percent of most industrial commodities, a pace that can’t be sustained. The pace should slow in coming years, as China moves to reduce its reliance on exports and investment, and to build an economy driven by local consumers. They are already making efforts to improve the efficiency of manufacturing operations and power generation, if for no other reason than to reduce their dependence on imports.
We will only see with time if Sharma is correct in his analysis but the article does make interesting reading and as so often in the past we ignore the lessons of history at our peril.