MINING FINANCE / INVESTMENT

Metals commodities outlook positive despite forecasts of rough going in 2009

BMO’s Bart Melek notes that the sentiment at the recent LME Week was not as bearish as one would expect given that many metal prices are so low and some miners are operating below cash costs.

RENO, NV - 

Participants at the recent London Metal Exchange Metals Seminar 2008 in London expect metals to be under pressure, but are optimistic about their long-term future owing to strong developing world demand and the potential for tight supply/ demand conditions.

In an analysis published Monday, BMO Capital Markets Global Commodity Strategist, Bart Melek, said, "The vast majority of the clients, producers and associates we met at the various events were resigned to accept that it will be very rough going for metals for the better part of 2009 as the global recession runs its course..."

"Most participants have even accepted the inevitability of a slower China next year-the primary source of the commodity boom," Melek noted. Despite the current gloomy scenario, LME conference attendees have a continued expectation that China will support metal demand in 2009 and over the long term, "a view shared by BMO," Melek stressed. "Expectations of eventual large-scale production cuts were also seen as supportive of prices in the longer-term."

Considering the time lag between lower prices and strategic mining production cuts, Melek forecast that "base metals inventories are expected to rise sharply-a trend being reflected in LME inventories. This also implies that the mining industry will run at a relatively low utilization rate, pushing marginal costs and prices still lower. Any time the commodity market goes from deficit to surplus conditions, prices drop sharply, owing to the steepness of the supply curve near the top of the cost distribution."

The arguments that China will support metal demand in 2009 and the long term include: retail activity in China is up 23% year to date, exports are still 22% up over a year ago and fixed asset investment growth may top 25% for the sixth consecutive year.

"In addition, the country has announced that it intends to spend massively to fix the damage caused by the  winter storms/earthquakes earlier this year and proposed fiscal measures aimed at boosting the property market and helping the textile and machinery sectors help the outlook," Melek said.

"Furthermore, Chinese interest rates have dropped twice recently and reserve requirements are on the decline. After the relatively poor GDP showing in Q3/08 and given less inflationary pressures, one can be quite sure that more monetary stimulus is on the way. These factors all support demand for metal as 2009 unfolds," he added.

Melek suggested that other developing world economies should also be major metals consumers once the current recession passes. "In addition, the western world will grow again in the latter part of 2009 and there could be a drought in new project financing due to difficult financial market conditions."

"Add to this the recent price declines, already existing supply side rigidities (labour shortages, low ore grades, geopolitical risk) and the credit crunch, and you get slow supply growth into the future," Melek said. "As such, when western demand returns, future shortages and sky high prices are a distinct possibility once the pending inventory overhang unwinds (likely after 2010)."