Global Story: Commodities outlook still bullish - Achieve Magazine, August 2006

Commodities outlook still bullish

by Andrew Pease, Investment Strategist, Russell Investment Group.

The tax cuts announced in the May Budget owe a great deal to economic growth in China and the resultant burgeoning commodity markets. While there was a correction in markets during the 30 June 2006 quarter, the long-term outlook for commodities remains bullish.

Earnings from Australia’s commodity exports have been forecast to rise by 25% this financial year and a further 7% next year. According to figures released by the Australian economic research agency ABARE, this will take earnings to a record $134 billion in 2006–07.

“The boom in commodities has had a strong impact on the Australian sharemarket...”

It is growth such as this that has resulted in a boom in Australia’s terms of trade and bolstered government coffers to deliver the healthy tax cuts.

Australia is one of the world’s largest suppliers of coal, iron ore and alumina so it’s in a box seat to benefit from the continuing strong growth in China, India and other emerging markets.

Already the economies in those States particularly exposed to the resources boom – namely Western Australia and Queensland – have forged ahead. In the year to March the WA economy jumped 10.6% outstripping the growth currently being experienced in China. Queensland, meanwhile, saw 9.2% growth dwarfing NSW at just 2.1%. Drilling down, the boom has triggered unprecedented demand for residential property in WA as workers migrate west to cash in on the boom. House prices in Perth, for instance, surged 28.8% compared with a national growth figure of just 3.6%, according to figures from the Australian Bureau of Statistics.

Modest slide

Interestingly, while commodity prices were at record highs in the March quarter, they were no higher in real terms than the levels of the late 1980s. And compared with the 1970s they are close to the average for that decade, based on the Economist metals price index.

Despite coming off the boil in the current quarter, it’s likely they will resume their upward trend in the longer term. In the first four months of this year, copper rose 58%, nickel 39%, zinc 69% and gold 27%. The star performers were copper and zinc, up 164% and 215% respectively over the 12 months leading up to the market peak in mid-May.

When you compare that growth with the subsequent correction, the slide in the second quarter of 2006 has been fairly modest. Gold, for example, has fallen just 15% from its peak in May, copper 15%, nickel 3% and zinc 18%.

Upward trend

A number of factors will contribute to commodities trending higher over the next 10 years. These include:

• Industrialisation in China, India and other emerging markets ensures that metals consumption per head will continue to grow rapidly. While China accounted for 60% of the growth in global copper demand between 1998 and 2004, annual consumption is still only five pounds per person compared with 16.5 pounds in the US and 39 pounds in Korea.

• Supply of commodities is unlikely to keep up with demand as it will be a number of years before renewed exploration and investment spending results in significant growth.

The boom in commodities has had a strong impact on the Australian sharemarket where mining giants BHP Billiton and Rio Tinto have enjoyed strong growth. But in the wake of commodity prices coming off their highs, both stocks lost around 20% apiece, but have since rebounded somewhat.

It is believed the volatility in the market will be short-lived and the growth in resource companies will pick up again as they reap the benefits from continuing Chinese and Indian demand.

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