Why the commodities boom just won’t slow down
By
Dominic Frisby Jun 25, 2008
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The next big inflationary threat – steel prices
This week we saw a 96.5% rise in the price of iron ore. Yes, 96.5%.
The oil price has refused to budge below $130 a barrel, despite Saudi pledges to increase production and the best efforts of those two fixers, George Bush and Gordon Brown.
And Her Majesty’s Treasury released this summer’s must-have beach-read - a 70-page document entitled, Global commodities: a long-term vision for stable, secure and sustainable global markets.
The commodities boom is not rolling over. In fact, it is gathering pace.
Anyone who thinks China’s insatiable hunger for metals is going to subside any time soon need think again. On Monday it was announced that Chinese steelmakers has agreed a new contract with Rio Tinto for the price of iron ore which saw a 96.5% rise on last year.
Like coal, the price of iron ore is not set in any futures market, so governments and lazy journalists cannot make any wild claims that speculators are somehow to blame for this one. Rather, an annual contract is agreed between the major producers (BHP and Rio in Australia and Vale in Brazil) and the major steelmakers (China) and that tends to become the guide price for the year.
Normally, the cycle is that Brazilian miner Vale agrees a price in the spring with the Chinese, which becomes the benchmark for the Aussie miners BHP and Rio. Vale negotiated a 65%-71% increase earlier in the year, but that wasn’t enough for Rio. They argued that they should be paid a higher price than the Brazilians because, with Australia’s proximity to China, Chinese shipping costs are lower.
Rob Clifford, of Deutsche Bank, said that, based on Rio's agreement, Australian ore trades at a $39-per-tonne discount to the Brazilian ore at current spot freight rates. It would have been $47-per-tonne if Rio had settled at Vale's level, he said.
But despite this record price rise for Rio, BHP says the increase is not enough. "There are still big differences between what we want and what they are requesting," it said.
BHP, it seems, have another agenda. They want to end the annual contract system which has been in place since the 1960s. Marius Kloppers, BHP Billiton chief exec, said they would not sign any new traditional annual contracts, preferring “new contracts on new transparent terms”. It seems he wants a system that also incorporates some kind of spot market with automatic price revisions that will reflect any tightness in the market.
Will steelmakers absorb these new higher prices? Will they heck! The rise in costs is going to be passed on to customers, which will mean higher costs for construction companies, car manufacturers, you name it. This will subsequently lead to yet more inflation. The Bank of England governor had better brace himself.
This the largest ever annual price rise and disproves, once again, the notion that a US slowdown will lead to lower commodities prices. It doesn’t work that way.
The argument of shipping costs has, of course, much to do with oil prices. Despite the best efforts of governments worldwide and Saudi pledges to increase production; despite most commentators (including me) stating it was overbought and due a retrace; the oil price remains stubbornly high. It is now almost two months since we crossed $125 and we have remained above $130 for fourteen days in succession. What we thought might be a short-term spike in an ongoing bull market, now looks to be a consolidation at higher levels.
There are some inventory level numbers out later today. These numbers never seem to be good, so we may get a further spike on the back of these.
Finally, HM Treasury released a 70-page study on the commodities markets called Global commodities: a long-term vision for stable, secure and sustainable global markets. It’s not exactly a page-turner, but whoever has compiled it – and no one seems to have put their name to it – has been extremely thorough in their research and should be applauded.
It’s a little light on precious metals for my liking - but then I’m an old goldbug – although it does spell out the role of gold as a hedge against inflation. It focuses more on energy and food, and it spells out pretty clearly what’s been driving these higher prices, what the consequences for the poor around the world will be if these higher prices continue, and what governments should be doing about it.
Unfortunately, what’s worrying for us in the UK is that there is in fact very little our government can do about it except make noise. We don’t mine any metals, we consume way more energy than we produce, our production of soft commodities such as cotton, sugar, cocoa and coffee is virtually non-existent. At least we do still have a farming industry – just. I hope those involved in it enjoy a long-overdue boom.
Turning to the wider markets…
UK shares had a volatile day but still ended the session lower after a weak opening on Wall Street, with the FTSE 100 index retreating another 33 points in a 0.6% drop to 5635. The FTSE 250 slid 1.4% to its lowest level since July 2006. J Sainsbury slipped to a two-year low after the latest industry data added to market share concerns. Tesco lost 3.4%, but Wm Morrison firmed 0.1%. Banks rallied, with Bradford & Bingley bouncing 17% after Resolution¹s proposed capital injection. Alliance & Leicester recovered 7% and Barclays 3.7%. Domino's Pizza plunged 14% after director selling.
European markets continued to suffer, with the German Xetra Dax and the French CAC 40 both losing 0.8% to 6,536 and 4,474 respectively.
US stocks fell to their lowest point for three months as poor consumer confidence and housing numbers weighed on sentiment. The Dow Jones Industrial Average slid 35 points, a 0.3% drop, to 11,807, while the wider S&P 500 eased a similar amount to 1,314. The tech-heavy Nasdaq Composite fell 0.7% to 2,368.
Overnight the Japanese market eased slightly, with the Nikkei 225 slipping 20 points to 13,830. But in Hong Kong, the Hang Seng put on 139 points to 22,595.
Brent spot was trading this morning at $137, while spot gold was at $889.
Silver was trading at $16.76 and Platinum was at $2021.
In the forex markets this morning, sterling was trading against the US dollar at 1.9671 and against the euro at 1.2647. The dollar was trading at 0.6430 against the euro and 107.99 against the Japanese yen.
And this morning, Barclays has said that it plans to raise £4.5bn to shore up its balance sheet, by selling stock mainly to investors in the Middle East and Asia. The move is designed to lift Barclays’ core equity Tier One capital ratio from 5% to 6.3%. The group plans to maintain its dividend at last year’s level, and pay it in cash, until dividends are covered twice by earnings.
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Dominic Frisby
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