Editorial: IMF gets bearish on metals

The International Monetary Fund made headlines in the world’s financial press earlier this month with a remarkably bearish take on the future of metals prices.

The predictions were tabled in a chapter entitled “The boom in non-fuel commodity prices — can it last?” in the IMF’s twice-annual World Economic Outlook. The chapter’s author is economist Martin Sommer, assisted by Christopher Gilbert and Angela Espiritu.

First off, the IMF notes that world economic growth and annual changes in real metals prices correlate at about 50 percent, and that almost all periods of large upward movements in metal prices have been associated with strong world economic growth.

With the world’s Gross Domestic Product (GDP) growth humming along during 2002-05 at an impressive 4.8 percent annually, up from 3.5 percent in the 1993-2000 period, it’s no suprise that metals demand has been so strong lately.

Adding to that, the increased demand has consistently exceeeded new supply, allwing metal prices to rise 180 percent in real terms since 2002, even outstripping the increase in oil prices, whcih clocked in at 157 percent in real terms.

(The IMF takes special care to pooh-pooh the notion that speculators in the commodity-futures markets have driven up metals prices, noting that speculators have built both long and short positions with offsetting effects on price movements).

Of special importance during the 2002-05 period, China’s share in world GDP grew to 13 percent from 10 percent, and the country took centre stage in the supply-demand balance for metals, contributing about 50 percent to the increase in net world consumption of the main metals — i.e. aluminum, copper and steel.

With regards to whether the strength of Chinese demand for metals is temporary or permanent, the IMF remarks that history suggests metals consumption typically grows together with income until about US$15,000-US$20,000 per capita (in purchasing power parity, or PPP, adjusted dollars) as countries go through a phase of industrialization and infrastructure building. At higher incomes, growth typically becomes more services-driven and therefore, the metals use per capita starts to stagnate.

The IMF says that China, with its current PPP-adjusted real income of about US$6,400 per capita, has so far tracked the patterns of Japan and Korea during their initial development phase, and this trend is likely to continue.

But getting to the heart of it, the IMF’s baseline scenario forecasts that the real price of aluminum and copper will fall by 35 and 57 percent, respectively, by 2010.

The IMF says this is consistent with history — that metal prices tend to converge to production costs in the medium term, and the current prices are well above today’s production costs (the ratios of market prices to costs are historically between 1.5-2.75 for the main metals).

The IMF’s conclusions are in opposition to experts such as Barclays Capital, who argue that the rise of China and other large emerging markets have led to a fundamental change in long-term price trends, and the world has now entered a period of sustained high prices, particularly for metals.

The big problem we see with the IMF report is its unwarranted confidence that production costs can be held around current levels. Though the report mentions that production costs vary considerably over time, mainly reflecting energy prices, exchange rate changes, and cyclical factors such as availability of skilled personnel and hardware, there’s no recognition in the IMF’s price models that the overall quality of mineral deposits and projects is declining worldwide.

Instead, the IMF report gives us this stunning quote: “in contrast to hydrocarbons, overall reserves of base metals are practically unlimited.”

Well, here’s what we see in our industry: ore grades dropping; new underground mines being developed at more extreme depths; new open-pit mines being built at ever-higher elevations; new mines being located in regions of extremely hot or cold climates; new mines exploiting metallurgically problematic ore; mineral deposits and mines under threat of expropriation by Third World governments; and mining projects being held up in developed countries by environmentalism or aboriginal land claims.

Add in soaring costs for miners worldwide for energy, consumables and labour, and these trends will invariably push up production costs, and thus in our view providing a higher floor for metals prices.

The IMF also notes that 36 countries have a ratio of non-fuel commodity exports to gross domestic product of 10 percent or more. In many poor countries, most export earnings come from just a few commodities.

So what’s more disturbing about the IMF report is its recommendation to policymakers in exporting countries that they should “ensure that the current income windfall is either largely saved — such as in the case of Chile — or used in a way that supports future growth in non-commodity sectors, for example through investment in education, health and infrastructure.”

That’s right folks, the IMF’s boneheaded advice to Third World governments of mining countries is: take what’s perhaps your most-profitable export-earning industry and stop reinvesting in it.

Let’s hope no one’s listening.