Short- and Long-Term Resource Trends to Watch

Here are three factors that are weighing on resource markets right now. Below, we look at some longer-term trends that should support resource prices despite today’s turbulence.

1. European instability worsens; Spain tips into recession: The main factor driving resource prices down this week was the ongoing fallout from the May 6 Greek election, in which no party won enough seats to form a government. Talks to form a coalition government ensued but soon collapsed because none of the parties could agree on whether to continue with sharp cuts to government spending. These reductions are necessary if the country is to continue receiving bailout loans from the European Union and International Monetary Fund. As a result, new elections have been called for June 17. Investors are concerned that anti-austerity parties could win an even larger proportion of the vote, paving the way for the country’s exit from the Eurozone, a move that would create further instability. As well, Spain, the fifth-biggest economy in Europe, officially fell into recession after it reported its second consecutive quarter of economic contraction on Friday. In the first three months of the year, Spain’s GDP declined 0.3 percent from the previous quarter, when it fell the same amount. Household spending dropped 0.6 percent.
2. China’s economy is slowing: China’s economic growth slowed to a rate of 8.1 percent in the first quarter of 2012 from 8.9 percent in the fourth quarter of 2011. As well, the State Information Center, a government think tank, said on Friday that growth could slow to 7.5 percent in the second quarter. If that prediction holds, Q2 will be the slowest quarter for the country since 2009 (though the consensus forecast from private sector economists calls for a less dramatic easing, to 7.9 percent). However, the State Information Center also said that it expects the country’s inflation rate to continue its decline to around 3.3 percent in Q2. That would give China’s central bank more leeway to stimulate the economy, including interest rate cuts.
3. Metal inventories are rising: Also causing concern is a rising tide of metal inventories as demand slows. According to Reuters, China’s copper supplies now stand at 1.4 million tonnes, the most since 2009. The country’s inventories have dropped 3.5 percent in the past month, but that’s half as fast as they declined a year ago. Iron ore is also piling up, as steel mills buy less steel in response to lower global industrial demand.“We’re not in the mood to buy cargo at this point, because it would be very difficult to sell in the current environment,” said a Shanghai iron ore trader.

Longer-term resource demand looks brighter

Despite these concerns, there are a number of positives that should push up resource prices in the longer term. Here are three trends to keep an eye on:

1. US industrial demand is improving: As was recently reported, US industrial output rose 1.1 percent in April, its biggest jump since December 2010, while housing starts rose 2.6 percent, topping analysts’ expectations. If that trend continues, a wide range of base and industrial metals, including copper, aluminum, and iron ore, stand to gain.
2. Japan’s reconstruction is steaming ahead: Japan has already begun to rebuild after the devastating earthquake and tsunami in March 2011, but it still has many years of reconstruction ahead. In all, the rebuild is expected to cost $180 billion, with 10 percent of that going to steel alone. That’s a plus for iron ore, an important element in steelmaking.
3. Rising corn prices could drive up potash demand: According to Bloomberg, corn prices have jumped 9.1 percent since May 11. That’s because a hot, dry summer is forecast for North America, and investors are concerned that this could result in lower US crop yields. A rising corn price would encourage farmers in other parts of the world to step up their corn production, which could increase sales of fertilizer, in turn pushing up potash demand.

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.