FYI | Feb 13 2008
If making forecasts was as simple as adding up a few numbers, divide it by key factors and then multiply by certain values, we’d all know what stocks to buy and when prices for key commodities would finally start trending down. Unfortunately, the art of making price forecasts requires a little bit more, and then there’s always the sudden impact from the unknown event.
This year, so much seems true already, will be the year that the world will learn that power supply is not necessarily a given. Already, we’ve read and heard about large scale power shortages in South-Africa and China. As both countries have a major mining industry, the impact on international commodity prices could potentially be significant.
At the beginning of each calendar year securities analysts line up their price forecasts and some services, like Reuters, compile handy and compact overviews from these data. Last year, each of those overviews indicated prices would fall for most base metals and, if my memory is correct, consensus predicted modest gains only for precious metals. As it turned out, the first six months saw many metals (remember nickel and later lead ?) soar to new highs, while precious metals waited until the last months of the year to take off like a rocket.
This year’s forecasts are pretty similar, consensus doesn’t see one single base metal improving in average price compared with 2007. Consensus in January, that is. (I suspect most of those forecasts were actually made before Christmas). Copper seemed like the main exception with the market predicting a rather stable price development in 2008 compared with last year. Since those overviews were compiled and published price expectations for aluminium have improved. Up to a point that some experts now genuinely believe aluminium may finally have its moment in the sun and record an average price increase this year. Some are even speculating on a significant price jump. I have an early suspicion that something similar is happening with regards to tin.
And oh yes, rather minor price increases had been expected for precious metals. Silver was even expected to decline in price average this year.
I don’t want to go into the “US recession but China will save us” discussion (I have a more important story to tell), let’s just say for now the matter is much more complicated than simply comparing the size of both economies, or the growth of their demand, to determine whether Super Cycle prices will last for much longer or not. Personally, I think most of the arguments brought forward about this matter are either too simplistic, or manifestly incomplete. As I gain more and more insight into this matter with every passing day, I also think criticising securities analysts because their price expectations have been lagging actual prices over the past few years is equally too easy and too simplistic.
(I’d like to spend some more paragraphs on this matter, but unfortunately I have to move on)
The fact that metals prices are expected to decline this year is in itself not so strange. After all, global economic growth is decreasing and this includes the three major developed economies on the globe: the US, Japan and Europe. Add some slowing down in China as well and what you end up with seems pretty much a straightforward conclusion. Except for the fact that it isn’t.
Whether the copper market will end up with a surplus or a deficit this year (to pick just one out of the pack) is not solely dependent on how much copper demand will grow or fall this year – a factor that is too often overlooked is the question how much of all the projected supply will actually be achieved?
This is where the world is about to receive a wake-up call – a serious one. Investors with a knack for base metals and mining stocks better pay attention because this is only getting more and more exciting.
Power shortages will increasingly become a feature this year. In South-Africa, for instance, the problems that came to the surface over the past few weeks seem endemic of a deep ingrained, structural issue – not just something that -oops!- happened and will be solved tomorrow. South-Africa is a major producer of gold, coal and platinum and mining operations will be affected by brown outs and blackouts in the national power supply system. Has anyone checked what has happened to the price of platinum lately?
Imagine what would happen were the world’s largest supplier of copper to experience similar problems.
Well, now we’re mentioning it, Chile is actually a disaster waiting to happen. The reason why you haven’t read about this elsewhere is because the world, including the financial press, is all looking at China and its snow storms and at Queensland, because that’s where the floodings are, and at the US because we have yet to determine whether the world’s largest economy is in recession or not. Chile is not high on anyone’s agenda right now, but I have a strong suspicion this will change in the weeks and months ahead.
“The only thing that remains to be seen is not whether the country goes through an energy crisis, but how deep that crisis will be.” Such is the conclusion drawn by Latin America specialists at US based researchers Hallgarten & Company. As recent as February 6 a Bloomberg journalist picked up an admission from a government official that the Chilean energy system “is close to breaking down” (admission by Senator Balde Prokurica of the Chilean government mining and energy committee).
So what’s happening over there? What’s this coming disaster all about?
Chile is suffering from unusually dry weather, a gas supplier who doesn’t deliver and soaring prices for fuel and diesel. The country is highly reliant on hydroelectric power generation, but no rain means no electricity. So the country has had to switch to an increased reliance on thermal power stations running on natural gas or fuel oil/diesel. The problem is, however, Argentina is not supplying the gas it used to, so the only alternative left is to generate as much power as possible from fuel oil and diesel – at a cost estimated some 80% higher compared to gas.
While the Chilean government is frantically trying its best to avoid a complete disaster, it is but a logical conclusion that smaller disasters will occur over the next few months. Already, Chileans have been asked to become power efficient very rapidly; the usual 220 voltage on the national power grid has been reduced to 198v for the time being. The industry has pledged to turn off non-critical machinery, while government offices are operating under an enforced 5% cut in power consumption. Day light savings time has been extended into March.
However, as is always the case under such circumstances, negative news simply brings out more negative news. One of the largest thermal generators, Nehuenco I, taken offline for repair late last year won’t come online for at least another five months. When operating Nehuenco I supplies about 11% of the country’s thermal power, which translates into circa 6% of total power supply. According to experts it is now plain impossible for the remaining thermal generators to fully satisfy the country’s power demand in the four months ahead – and this is counting on the fact that rain will arrive in June.
Chile is the world’s largest supplier of copper. There’s little doubt the current problems will affect the local economy, and this includes the Chilean copper industry. How much supply will be affected is anyone’s estimate at this stage, but it doesn’t take much to turn a finely balanced market (as copper is believed to be at the moment) into a deficit.
My best guess is that some hedge funds, who may have been positioned to go short in case more negative news from the US, China or Europe would erupt, are now reversing their strategy. As common logic would tell you, it is only a matter of time before Chile hits the international newsheadlines, and when that happens it will mean bad news for buyers of copper.
Till next week!
Your editor,
Rudi Filapek-Vandyck
(As always supported by the Ab Fab team of Sophia, Grahame, Greg, Paula, Chris, Pat, George and Joyce).
