Under-investment in mining capacity is one of the reasons behind the current metals price inflation.

By Tom Stundza -- Purchasing, 8/14/2008

Metals prices overall now are in the seventh year of a bull-pricing phase, a so-called supercycle, that actually started in 2002. Since then, nonferrous metals traded on the London Metals Exchange (LME) have increased in price by more than 300%. What caused this super cycle in nonferrous? The lack of investment in sufficient new mining, smelting and processing capacity in the 1990s. This has made nonferrous metals supply insufficient to meet the demand surge this decade from Brazil, Russia, India, China and such developing nations as Thailand and South Africa.

Supply-side issues have distinguished several nonferrous metals markets so far in 2008.

"Fundamentals are proving, as they always do, to be the best predictor of price dynamics in the diverse commodity markets," says analyst Gayle Berry at Barclays Capital Research in London. "Although there are some tentative signs of a slowing in global commodity demand, the overall picture is a robust one with strength in China and other developing regions more than offsetting weakness in North America and Europe." The key is that supply isn't matching that demand for some metals.

Commodity bulls see higher metals prices as the key to solving the long-term supply-and-demand imbalance. When prices go high enough, consumption will fall, they say, and production will increase. But, in the short-term, pricing will depend on which force prevails for traded metals—inflation fears or physical demand for metal. Recessionary worries have hit only a few industrial metals lately as supply has outpaced demand. And all are coating or plating metals—zinc, tin and nickel.

Since 2002, prices of steel in all shapes and grades have increased by almost 170%. Prices of the commodity carbon steels have seen growth volatility caused by the unpredictability of scrap, iron ore and energy costs; the availability or lack of mills products; and erratic demand trends within the various metals and ores.

Patricia M. Mohr, vice president of economics and the commodity markets specialist for Scotiabank Group in Toronto, tells Purchasing in an interview that "tight global supplies, rapidly growing demand from steel producers outside North America and Europe, especially China and emerging Asian nations, and strong business investment in basic processing industries account for the strengthening of iron ore prices." And, since iron ore suppliers have been consolidating, she says the current rate of inflation, at 97% so far this year, will continue for some time.

Charles Bradford, president of metals consultant Bradford Research/Soleil Securities in New York, says vertical integration suddenly is becoming important for steelmakers because of the rising costs of such key raw materials as coking coal, iron ore and scrap. Indeed, a new investment arena has been scrap steel, where demand has been so strong— and with it, prices. So, several large scrap companies in the U.S. have been bought by electric furnace steelmakers to ensure present and future supply. That's because the steel scrap market is volatile, with prices up above $785/metric ton for the premium grades this year, which is almost $300 higher than last year's highs.

Speaking to Purchasing, CPO John Campi of Chrysler says "we have to adjust our purchasing and adapt our manufacturing to a new reality, which is that metals prices are elevated and will stay that way for some time." He agrees with Leo Torres, CPO at Ford de Mexico, that "purchasing can't fight with our suppliers over prices; instead, purchasing has to lead the corporation's improvements in buying the best and most competitive metal and metal parts."

The global copper cathode market is expected to remain tight and support higher copper prices because of a severe shortage in concentrates, the smelter feedstock, caused by weaker mine output so far this year, according to commodities researcher Nicholas Snowdon at Barclays Capital Research in London. He projects that world inventories at midyear account for less than three weeks worth of world consumption. "Our balance projections suggest a very tightly balanced market," he says, "So prices are likely to be especially sensitive to fluctuations in Chinese demand and imports."

His research shows that recent mine supply has not kept up with demand growth because of labor strikes, lower ore grades and energy shortages. So, he forecasts that global copper mine production will grow by only 350,000 metric tons this year while consumption will grow by nearly 750,000 metric tons—supported by "healthy increases" in Latin America, the Middle East, China and other parts of Asia. However, while copper production is up about 25,000 metric tons this year in Chile, the world's largest source, output in Indonesia is down nearly 90,000 metric tons. So, the Barclays Capital analyst says that "refined copper production is continuing to expand steadily, but only at the cost of rapidly depleting concentrate stocks and soaring use of secondary materials."

The high cost of production and the lack of new mining/smelting projects in the pipeline have long been discussed as factors supporting nickel's dramatic LME price drop over the past year. But, a new Deutsche Bank quarterly commodities report suggests that the substitution threat from nickel pig iron, especially in Asia, was "a main driver of the nickel price crash" from $16.88/lb in 2007 to $12.38 at mid-2008. Stronger second-half demand from Chinese specialty steel mills and lack of new smelted nickel production are expected to support an annual average of $13.40 this year, according to the bank's report.

But the price outlooks for 2009 range from $14–15 for the bulls who see a pickup in 2009 global stainless steelmaking to $11–12 from the bears. They aren't convinced that a global economy pickup will occur until 2010 so next year's stainless steelmaking will stay pretty stable and there could be some new supply "to fill a persistent supply deficit," says the Deutsche Bank report. The Santa Rita nickel project in Brazil, said to become the third-largest open pit nickel mine in the world, will be producing halfway through 2009, says the owner, Australian producer Mirabela. However, production isn't scheduled until 2010 for the Kennecott Eagle $300 million nickel mine in Michigan, and BHP Billiton's $4 billion nickel project on Gag Island off the western tip of Papua New Guinea still is in early development.

The tin market is being buffeted by supply woes ranging from unexpected purchasing from LME stockpiles to dramatically reduced supply from Indonesia to China's return to being a net tin importer. Several analysts' reports all conclude that the tin supply chain will remain problematic through 2009—unless there is substantial new world supply from Indonesia or China.

Some background: Indonesian authorities clamped down on operations of unlicensed independent smelters in October 2006, which led to shutdowns. That was followed by even-stricter regulations on operations and reduced authorized exports by smelters and regulations on the procurement of tin concentrate. Meanwhile, China turned into a refined tin and alloys importer last August and has grown imports while reducing exports. A Barclays Capital report says "tightness in concentrate, off 10% year-on-year through April, high domestic prices for tin metal and a new, steep export tax all have reduced export attractiveness for Chinese producers."