Between the end of 2002 and now, commodity prices have racked up huge rises: coking (steel-making) coal by 520 per cent, iron ore by 420 per cent, copper by 420 per cent, tin by 400 per cent, lead by 360 per cent, thermal (electricity generation) coal by 330 per cent, oil by 320 per cent, nickel by 230 per cent, zinc and gold by 150 per cent and aluminium by 120 per cent.
The commodities boom has been mainly driven by China’s – and to a lesser extent, India’s – need for raw materials and power. As the massive Chinese industrial expansion hoovers up Australian commodities as fast as they can be mined or pumped, the commodity price strength has helped push many miners’ profits and share prices to record levels.
That’s the good news.
The potential bad news is that a “super-cycle” is still a cycle – and at some point, the Chinese economy could run out of puff, putting the global resources boom under pressure, and with it, Australian resources companies’ share prices.
The Olympic Games later this year could provide a short-term turning point for the Chinese economy. Global manufacturing expert Kevin Gromley, director of Asia-Pacific manufacturing Deloitte Touche Tohmatsu, is one observer worried about this: he says huge investment in building has created the risk of a bubble-like effect following the end of the Beijing Olympics, as the economy pauses to catch its breath. “There is a risk that over-investment in infrastructure (in the lead-up to the Games) will cause a bubble effect, particularly after the Beijing Olympics,” says Gromley.
The Chinese themselves expect their economy to slow from its average growth rate of 12.8 per cent a year since 2000. On 10 June, Xu Xianchun, the deputy director of China’s National Bureau of Statistics, was quoted as saying that the economy “might already have begun its cyclical adjustment,” and its growth was set to slow in the next few years.
“According to our initial judgment, 2007 was probably the peak point of the current Chinese economic growth curve. The growth rate from this year on will slow down gradually,” Xu told China Economic Weekly.
Does this mean a spell on the sidelines for the long-running resources boom on the Australian sharemarket?
Not necessarily, says Peter Quinton, head of strategy at broking firm Bell Potter – because the commodities boom is not wholly a China story.
Although the main emphasis is rightly on China as the growth engine of raw materials demand, and the other three nations in the BRIC (Brazil, Russia, India and China) grouping, Quinton says there is another block of countries that is just as important in the commodities demand picture – but which are “largely ignored”.
Quinton calls these countries the “next billion”, because like each of China and India, they have an aggregate population of more than one billion people. The “next billion” includes the oil-rich economies like Saudi Arabia and the Gulf States, the stgeloping ASEAN (Association of South-East Asian Nations), Eastern Europe, Latin America and Africa.
Just like the BRIC countries, he says, the “next billion” countries will be industrialising and urbanising and building vast amounts of infrastructure over the next decade or more.
“In 2022, we estimate that the ‘next billion’ countries will account for about 70 per cent of the world’s consumption of most commodities, with the notable exception of oil, where their share will be 44 per cent. Investors are yet to fully recognise the rapidly rising commodities-intensive nature of future global economic growth, which means that high commodity prices are likely to persist for an extended period of time.”
Quinton says the resources boom is “nowhere near played out”. “Resources is a ten-year, if not longer, story. It’s going to be intact as an investment theme for that time, but that doesn’t mean that the share prices of the resources companies can’t have very volatile moves – both up and down. But investors shouldn’t care if resources stocks fall by 15 per cent in the next two months – it’s irrelevant, because if you’re playing the theme, you’ve got to think about the stocks as rising in an uptrend in a channel. If you’re taking a five-year view, a short-term downward correction is irrelevant, because the underlying theme is just so strong – it’s just a chance to buy the dip. It’s coming back to the bottom of the channel, but that channel is in a five- to ten-year upswing.”
Jeremy O’Gorman, senior client adviser with broking firm Joseph Palmer & Sons, says it is “hard to argue” that the resources cycle is close to its top. “Rio Tinto and BHP Billiton have both warned that the commodity boom is not “stronger for longer” but “strong forever”. They believe that there is a “structural change” in commodity pricing, driven by the stgeloping world.
“Rio predicts that the global population will grow by 1.4 billion people between now and 2025. If you look at Rio’s projections of where that population growth is coming from it’s just about all from the stgeloping world. The stgeloping world will require raw materials, energy, water and food. 1.4 billion people are going to need critical infrastructure, and critical infrastructure needs plenty of raw materials to produce steel. Steel needs equal parts of iron ore and coking coal and as we all now know, China has limited amounts of quality coal and iron ore and is becoming increasing reliant on imports to meet their steel production needs.”
The Chinese economy has decoupled itself from the US, he says, with more than 90 per cent of demand being internally driven. “Infrastructure demand is approximately double GDP growth of 10 per cent, with urbanisation leading to the government’s five-year plan of spending $US 120 billion per year on infrastructure improvements in the way of 1,000 new water treatment plants, 45,000 kilometres worth of railways, another 97 airports and huge growth in car ownership/manufacturing. A massive appetite for aluminium, copper and steel has resulted and efforts to rebuild Chinese infrastructure following the earthquake will be highly metal/steel-intensive.”
While the local market continue to prices resources on a cyclical nature, O’Gorman says the longer this cycle continues, and the more interest international companies and investors show in our resource companies, it is hard to argue for a cyclical downturn.
The resources team at Macquarie Capital Securities Europe says the bulk commodities – iron ore and coal – have better prospects over the base metals (copper, zinc, lead, nickel and aluminium) in the short term: it says there is “downside risk” in some of the base metals.
Macquarie sees copper “edging into small surplus, but still vulnerable to supply disruption”; aluminium “in surplus, but supported by high costs, and likely to trade sideways”; nickel “moving from large surplus to very small surplus,” with prices supported by high production costs in China; lead still looking very tight, thanks to strength of demand growth in China; zinc moving into surplus, particularly in the second half of 2008 and 2009; iron ore “remaining tight”, with a large price rise in prospect for 2008; and both coking coal and thermal coal “extremely tight”, with strong rises in contract prices in prospect,
For 2008, Macquarie favours the bulk commodities over the base metals – but the investment bank says the longer-term “accelerated global demand growth story hasn’t changed.”
Quinton says there is an easy way to play the resources theme. “All you have to do is own BHP Billiton, Rio Tinto, Woodside and Lihir Gold. Then there’s no commodity that you don’t have exposure to. All of those commodities, in a long-term scenario, are going to rise, and if you buy those four companies, you’re buying at the Rolls-Royce end of the market, and you won’t have to worry about it. If you’re concerned about inflation, you’ve got the gold exposure as well.”
But commodity prices will still have “wide swings up and down,” he says. “It’s a volatile sector, and there could be a year – or even two – when commodity prices and share prices were lower. But the secular trend is very firmly in place, and you can ride through this.”
The commodities theme also lends itself to secondary exposures, says Quinton: the “storekeepers selling the shovels to the miners.” “The companies that provide services to the resources sector normally also supply services to the infrastructure sector. Those companies probably have very high revenue growth underwritten for at least the next five years, and probably longer.”
In this category he nominates engineers WorleyParsons and United Group, explosives and explosives and blasting technology group Orica and drilling equipment supplier and contractor Boart Longyear.
“Investors always have to look at the valuation, and there is always the prospect that this kind of stock can get overbought in the short term, but in that case they will correct back, and that’s when you buy them. Those kinds of companies don’t look overly expensive at the moment: the share prices have run quite strongly, but so have the profits. They’re not dirt-cheap anymore, but nor are they hugely expensive. But all of those resources suppliers are facing their own pressure on costs, and that’s where true good management will really shine,” says Quinton.
O’Gorman is similarly minded. “Outside the pure resource stocks, I would be looking at BlueScope Steel, One Steel, Monadelphous, Bradken and Transfield Services,” he says.