Some Base Metals to Drop 50%

An attention-grabbing headline no? The comments come from Michael Pettis, a professor at Peking University’s Guanghua School of Management in a report for McKinsey last week. The comments echo those of another knowledgeable China watcher we will come to in a moment. Unfortunately Mr Pettis’ comments only appeared in the print edition of the Telegraph.

His comments though followed a presentation made by Andrew MacKenzie, BHP Billiton’s new CEO, the keynote speaker at the Melbourne Mining Club, following a meeting with Li Keqiang, China’s Premier. Mr. MacKenzie warned that commodity growth in China could not support metal prices in the future as the country engineers a change from growth led by investment to growth led by consumption.

Consumption will create winners and losers among metals, demand for cars, washing machines, computers and even meat will rise further. But construction and heavy industrial investment will fall according to Mr Li.

Mr Pettis agrees saying the transition will mean the price of hard commodities will drop sharply. “China consumes a disproportionate share of the world’s hard commodities, such as aluminum, copper and iron ore. Adjusted for GDP the country buys four to ten times as much of these commodities as the rest of the world, demand that has driven the commodities super cycle for the past two decades. As China’s investment cycle slows so will its demand for hard commodities, whose prices may consequently drop perhaps by as much as 50% over the next few years.”

The falls in prices we have seen so far, off highs in 2011, come as a result of slow demand globally and particularly fears over China’s slowing economy – the switch to consumption has barely begun in real terms. Falls of the order of magnitude outlined by Mr. Pettis would result in the mass closure of mines and processors, which in itself would restrict supply and help support prices.

Mining and processing costs have risen and we tend to doubt any major metal could be produced at prices approaching 50% from current levels although iron ore costs, arguably could come down substantially and still create profits for miners.  Nevertheless when the head of the world’s largest mining company and eminent academics agree, it should encourage the rest of us to ponder which metal winners and losers. Which metals will gain the support from demand from a growing middle class and which will see price support erode over time remains unanswered.

China’s rise to dominate global metal prices happened quickly. The country’s transformation in the future may have every bit as dramatic an impact on prices as it has the other way.

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