Commentary: Commodity Prices To Bottom In 2009: Banks

While TD Bank sees the commodities market starting to rebound in the second half of 2009, followed by more pronounced price increases in 2010, the World Bank believes that, over the long term, commodity prices will remain substantially below recent bull market highs.

“The commodity market boom has come to an end,” the World Bank said in its recent report, Global economic prospects — commodities at the crossroads. The boom — which had been the most pronounced since 1900 and was the result of rapid demand growth that outpaced supply growth — ended because of slower growth worldwide, increased supplies and revised expectations.

The World Bank does not agree with observers who say that the global economy is moving to a new era characterized by relative shortage and permanently higher commodity prices. Over the long run, it expects commodity prices to fall, although not to 1990s levels, since such low prices would suppress exploration and new development in the resource sector.

Over the next two decades, the bank says gross domestic product (GDP) growth rates will slow because of slowing population growth and moderating income growth, in turn putting a lid on commodity demand growth. Moreover, technological progress should improve the efficiency of both production and use of commodities, ensuring that supply keeps pace with demand.

The World Bank says that, while commodity prices are likely to be higher than in the 1990s and early 2000s, a period when prices were depressed by excess supply, “the recent peaks (in prices). . . are unlikely to be the new norms,” since demand is not expected to outstrip supply over the long term.

The World Bank sees a marked slowdown in growth rates in the coming year, projecting that investment in developed economies will shrink 3.1%, while investment in developing economies will grow by 3.4% — a sharp pullback from the 13% growth seen in 2007. The bank forecasts that the global economy will grow by 0.9% in 2009. Developing economies are projected to grow by 4.5%, well below the 7.9% growth rate seen in 2007.

Phenomenal growth in China’s GDP has led to a rise in metal intensity in the economy, defined as metal consumption per unit of GDP. This trend is explained by the boom in investment, manufacturing and exports in China. Currently, metal intensity in China is four times higher than in developed countries and twice that of other developing countries.

China’s metal intensity is expected to stabilize in coming years and then start falling as high investment rates in the economy moderate, and the movement of manufacturing capacity to China from the rest of the world likewise slows down. Another factor that will decrease metal intensity in China is the changing makeup of the economy, where the share of services will increase at the expense of construction and manufacturing.

If China’s metal intensity stabilizes and then falls in coming years, global demand growth for metals, which has exceeded GDP growth rates, should first decline to match GDP growth rates and then drop lower. The World Bank forecasts that, between 2015 and 2030, the global demand growth rate for metals will be 2.7% per year.

Turning from metals to energy, the World Bank says that future energy demand growth depends heavily on the pace of technological innovation in the automotive sector. Energy efficiency in the transportation sector is key to moderating demand, since 75% of energy demand growth is projected to come from this sector.

The World Bank believes the prospects for technological improvements in the automotive sector are good, using technologies such as flex-fuel, hybrid cars, plug-in hybrids, electric cars and hydrogen-powered vehicles. Together, these have the potential to double fuel efficiency. The bank says that, by 2050, the market share of such innovative vehicles could reach 90% in the developed world and 75% in the developing world.

Oil consumption is forecast to grow to 114 million barrels per day in 2030 from 87 million barrels today. Energy consumption as a whole is projected to grow at a faster pace, since consumption of other energy forms (such as coal, natural gas, etc.) will grow faster than oil demand.

“Over the next twenty years, supplies of extracted commodities are likely to remain ample,” the bank says. The pace at which supply in the oil and metals sectors catches up with demand depends on how quickly the supply of labour and supply in the heavy and specialized equipment sector can be restored. Capacity in these sectors has been reduced by years of low prices and weak investment, leading to long delivery times and high costs.

Recent high prices have helped address these capacity constraints. With the current recession, and with lower commodity prices, investment demand has fallen, as has demand for and prices of specialized and heavy equipment. Despite this, prices are projected to remain relatively high and there will be a backlog in equipment deliveries for the next several years.

Metals and energy resources are unlikely be exhausted anytime soon, the bank says. Historically, reserves of both oil and metals have tended to rise faster than the depletion rate through extraction. In the case of oil, reserves have tended to remain at 40 years of anticipated consumption. This is because, when companies tally reserves, they tend to include only resources that can be readily extracted, which excludes sizable known resources.

The bank expects that more resources will be discovered, and that although likely to be lower grade or more remotely located, and therefore more difficult and costly to exploit, advances in extraction technology will offset these impediments. The long-term oil price–and the average for 2009 — is expected to be US$75 per barrel in real 2008 dollars, a level that would allow economic production from oilsands.

Even if the World Bank’s projection turns out to be partly wrong and certain resources do become scarce, the bank says that alternatives will start coming into play. For example, if the pace of oil discoveries declines, the rising oil price will make alternatives such as coal, nuclear, natural gas and renewable energy more attractive, as well as stimulating conservation and technological change. However, in such circumstances alternative energy sources would also become more expensive.

TD Bank economist Dina Cover focuses on short-term prospects for commodities. She has downgraded prospects for the global economy in 2009, projecting growth at a mere 0.5%. Cover forecasts that the U. S. economy will shrink by 2%, and growth in the Chinese economy will slow to 7.6%. Since the U. S. and China are the world’s largest consumers of many commodities, demand will be hit hard, particularly for oil, coal and industrial metals.

As a result, the TD commodity index is projected to fall by 15% from mid-December levels, for a 60% peak-to-trough decline, bottoming in the second quarter of 2009. This may drag the Canadian dollar further down, which should help cushion the effect of falling commodity prices on mining companies.

Energy and base metal prices will decline the most, since both consumer and industrial demand for them will decline. Although some mining companies — notably zinc, nickel, aluminum and potash miners — have slashed production, demand has fallen much more, so prices will remain under pressure in the short term. For example, the oil price is now expected to bottom at US$30 per barrel.

As for gold, TD forecasts that fears about deflation and disinflation could put downward pressure on prices in the near term, but a projected drop in the U. S. dollar in 2009 will support the gold price.

The global economy will start firming toward the end of 2009 and into 2010, lifting commodity demand and prices. TD expects a 55% rebound in the TD commodity index by the end of 2010, led by a doubling of the oil price to US$75 per barrel. Excluding energy, the index will rebound by only 22%. Commodity prices
are not projected to reach their boom peaks, since global economic growth in 2010 is forecast at a lukewarm 3.2%, substantially below the 4-5% growth rates seen during the boom.

Another factor that will limit commodity price appreciation is lower investment demand, since other asset classes will also rebound and compete for the same investment dollars.

TD projects that oil will cost US$45 per barrel in December 2009, rising to US$75 in December 2010; thermal coal in Australia will cost US$65 per tonne in December 2009, rising to US$100 in December 2010. The price of silver is forecast at US$9.60 per oz. this year, and US$10.50 in 2010; aluminum will be US75¢ per lb. in 2009, increasing to US$1 in 2010; copper will cost US$1.50 per lb. this year, rising to US$1.80 next year; nickel will fetch US$5.15 per lb. in 2009, rising to US$6.50 in 2010; and zinc is projected at US48¢ per lb. this year and US70¢ in 2010. Uranium oxide is expected to be priced at US$52 per lb. in December 2009, and US$65 in December 2010.

TD Bank forecasts that the only commodities that will fall in price between 2009 and 2010 will be gold and newsprint. The gold price is projected at US$815 per oz. in December 2009, falling to US$700 in December 2010.