Market conditions are also setting the scene for the next leg up of the commodity supercycle. There are three things that are happening today that will guarantee higher prices for commodities in the future, once the current jitters have started to ease.
In a bull market people get away with some shocking things.
A few years ago I met a 21-year old geography student. He had been investing in the stock market for years. He had seen some success, so now his biggest ambition was to get rich. Very rich.
He wrote for a few publications and through this work got to meet some interesting City players. They told him that the biggest game in town was floating companies on Aim, talking them up. This would make him rich, he believed. So, he decided to join the game. He formed a uranium mining company, installed a geologist to give it some credibility and listed the company on Aim. His stake in the company was worth tens of thousands of pounds. He was laughing all the way to the bank, he thought.
Not bad for a 21-year old. But the problem was that the company was never going to work. It held licenses for some scraps of land that might or might not have contained uranium, but the nature of the market meant that this did not matter.
However, reality eventually hit home, the uranium price slid and the company’s valuation was dragged down as well. Eventually the company was wound up.
I saw this sort of thing happen a number of times. Nothing that went on was illegal; I just found it all very distasteful. Shareholders who had passed over their cash in good faith were the biggest losers.
Perhaps one positive thing to come from the credit crunch is that the number of spivvy miners on Aim will decrease and we will be left with some quality companies. My young geography student chum would have no success in this market. This is a good thing.
Market conditions are also setting the scene for the next leg up of the commodity supercycle. There are three things that are happening today that will guarantee higher prices for commodities in the future, once the current jitters have started to ease.
Firstly, prices of virtually all base metals have fallen below the cost of production. This means one thing: closed mines. This will hit the supply side hard.
According to Ambrian Capital all base metals prices except copper have fallen close to their cost of production. If prices fall any further mines will be closed, which will cause supply to tighten and prices will rise. Let’s have a look at some figures.The marginal cost of zinc production is around about $1,900 per tonne. The price of zinc is now $1149.75 per tonne.
The marginal cost of production for lead is around $1,800 per tonne. The lead price is now at $1,352.
The marginal cost of production for nickel is around $17,000 per tonne. The nickel price is now at $10,620
Then we have to consider gold. The gold price is also supported by its production costs, particularly for small, early-stage producers.
Take Uruguay Minerals (UME). Last week the company said that the cash cost for each ounce of gold production was $792. Today, the gold price is at $807. If the price was any lower, the company would have to close its operations.
The credit crunch has made access to capital to fund new mines difficult to come by. This will also tighten the supply side.
Then there’s the maths companies did on new projects last year. The calculations are now all wrong.
To develop new projects, miners had worked out the costs using higher commodity prices in these calculations. Many of these projects will now be uneconomic at lower prices. They will not get off the ground. Yet again this tightens the supply side.
So, the economics of commodity production means that prices cannot fall much further. If they do, new production will be crimped and scarcity will lead to price rises.
I also do not believe that China is going to stop developing. New developments in the cash-rich Middle East also continue to soak up materials. Despite concerns of a global slowdown, the world will continue to develop.
The commodities supercycle is far from over, we are now in the intermediate stage before the second leg. This will be the best time to pick up commodity stocks in years. When the market settles, you should be ready to pounce on quality players. To find out more about Smart Commodities UK click here.
