Commodity prices reach 20-year high

From a research report by J. B. Were & Son, a member of the Australian Stock Exchange.

The current very strong metal prices are largely demand driven with most base metals now coming from almost fully utilized mines and smelters and little new capacity coming on stream in the short term. The key to the continued strength in prices is therefore very much shaped by the capital expenditure and industrial output cycles, particularly in Japan and the United States.

Industrial production is growing strongly around the world and the capital expenditure cycle appears to be in strong upswing in most major economies. It appears as though commodity prices will hold up until very late in the economic cycle. Indeed, while commodity prices may pause over the northern summer, a continued acceleration in commodity prices is likely throughout the remainder of 1988.

Over-all we expect annual average prices for 1988 and 1989 to be above 1987 making the collective 1987 to 1989 years the strongest commodity price period for at least 20 years, surpassing the 1979-1981 boom. The easing of prices from 1989 is expected to be far more gentle than the sudden drops seen in previous strong periods. Within this scenario, we see the strongest performing metals being zinc and tin closely followed by nickel and then copper. Lead could be surprisingly positive.

Supply of base metals is currently running at close to maximum levels as stockpiles built up over the last seven years are exhausted and mining operations are pushed to full tonnage and higher grade. Unlike previous peaks in resources cycles there are few major new mines opening or expansions coming on stream and little mothballed capacity available.

The shortage of major new mines is largely due to a lack of exploration for base metals since 1981. Recently, parts of the mining industry have warned of the fast depletion of known base metal reserves with reported figures in Canada showing falls of between 20% and 24% in reserves of nickel, copper and zinc. At the same time gold reserves increased by 94%. Two points to be made from this scenario are:

1. Depending on demand, we could see a long term positive outlook for base metal prices.

2. There may be a scramble for companies to re-establish base metal exploration portfolios.

Over the last 18 months world markets have been surprised by demand for commodities outstripping supply, particularly metals. The bear market for base metals which began in 1981 and ended in mid-1987 has passed into a controlled surge upwards, not a raging bull market with the investment community appearing to price mining stocks on the less volatile 3-month metal price rather than the highly roller coaster spot prices. This suggests a level of caution bred in October 1987. In our view, investors should use any short-term weakness in share prices (from weaker metal prices over the northern summer) as a buying opportunity for the remainder of 1988.