06 September 2012

Will Commodities Prices Collapse by 2015?

China economist and observer Michael Pettis expects commodities prices to crash by up to 50% over the next few years. Here is a rough outline of his argument:
China currently is the leading consumer of a wide variety of commodities wholly disproportionate to its share of global GDP.  The country represents roughly 11% of global GDP if you accept the stated numbers, and substantially less if you believe, as I do, that growth has been overstated because of the difference over many years between reported investment, i.e. its input value, and the actual economic value of output.  China nonetheless accounts for between 30% and 40% of total global demand for commodities like copper and nearly 60% of total global demand for commodities like cement and iron ore.

The only reason China has provided such an extraordinarily disproportionate share of global demand for hard commodities has been the nature of China’s growth model.  While China may represent only 11% or less of the global economy, it represents a far, far greater share of the world’s building of bridges, railroad lines, subway systems, skyscrapers, port facilities, dams, shipbuilding facilities, highways, and so on. 

Over the next decade, two things are going to change.  The first is increasingly recognized, and that is that Chinese growth rates will drop sharply.  The second is that China will rebalance its economic growth away from its appetite for commodities.

Which Way Can Prices Go?

For these reasons I am very pessimistic about hard commodity prices and expect them to drop substantially further in the next two to three years. 

Production capacity for hard commodities is rising much too quickly, in a belated response to the unexpected surge in demand just under a decade ago. Expected economic growth rates in the country that has been biggest source of new demand – virtually the only source – have fallen sharply and commodity prices have fallen with them.  Historical precedents and the arithmetic of rebalancing suggest, however, that the current consensus for medium-term Chinese growth is still too optimistic.  Expected growth rates will almost certainly fall further in the next two years.

Beijing has finally become serious about rebalancing China’s economy, and rebalancing means shifting Chinese growth away from being disproportionately commodity intensive. 

Instead of representing 30-60% of global demand for most hard commodities, Chinese demand will shift to a more “normal” level.  Remember that even a very limited shift – from 50% of global demand, for example, to a still high 40% of global demand – represents a sharp drop in global demand.

There has been so much stockpiling of commodities and finished goods with implicit commodity content in China that the country could well become a net seller, and not net a buyer, of a wide variety of commodities in the next few years.

This is going to come as a shock to many people.  In my discussions with senior officials in the commodity sectors in Brazil, Australia, Peru, Chile and even Indonesia, it seems to me that many analysts have been insufficiently skeptical about the Chinese growth model and are unaware of how dramatically the consensus has changed in the past two years. 

They have failed to understand how deep China’s structural problems are and how worried Beijing has become (this worry may be best exemplified by the extraordinary growth in flight capital from China since early 2010).

Under these conditions I don’t see how we can avoid a very nasty two or three years ahead for commodity producers.  This isn’t all bad news, of course.  What will be a disaster for hard commodity producers will be great news for companies and countries that are commodity users or importers.  One way or the other, however, we are going see a big change in the distribution of winners and losers. Read more at http://globaleconomicanalysis.blogspot.mx/2012/09/by-2015-hard-commodity-prices-will.html#VS6Z04Tib0oovfOx.99 _Michael Pettis _ via _Mish
More at the link above.

More: 6 Signs of China's Deteriorating Economy

We have looked at exactly this issue previously in relation to both oil prices and the commodities markets generally. China is the second largest national economy in the world, and the champion of the emerging nations known as the BRICs. Many people thought that China was ready to lead the world as a replacement superpower hegemon to the US.

Many people still believe in the idea of China as global leader, continuing to support exponentially growing global demand for oil, commodities, food, etc.

But it might be best to use caution when investing in any venture that is dependent upon continued massive economic growth in China. Only a fool bases expectations upon extrapolations without limits, constraints, and qualifications.

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“During times of universal deceit, telling the truth becomes a revolutionary act” _George Orwell

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