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Henry Thornton - Economics: A discussion of economic, social and political issues The Raff Report – May 17th, 2006 Date 17/05/2006
Member rating 4.6/5
The correction in the base metals market was inevitable, but the timing was uncertain.
By Nick Raffan Email / Print

Blood in the street, holy cow the press are going to have a field day with gloom and doom stories for commodities and resource equities.  Red inks every where but is it all justified?  In the case of base metals, a pullback was certain but as always timing uncertain.  As far as equities are concerned some small issuers had run ahead of themselves with respect to value, but in the case of the biggest miners, the sky-high metal prices were never priced into forward earnings by the market anyway.  Remember that mean reversion generally rules forecasts for reasons outlined in a previous Raff Report.

Most readers will have read comments in the newspapers over recent weeks made by RIO and BHP Billiton concerning the shortages of tyres, other materials, and professional staff. And on top of that a market that is expected to remain as strong as a bulls roar for the foreseeable future (keeping in mind those great words by Winston Churchill at the Yalta Conference).  With world growth expected to grow by nearly 5% this year and above 4% next year all looks good for resources.  Just imagine above 4% growth in 2008 and 2009?  The Raff Report has not cited any papers forecasting the collapse in world trade anytime soon.  Anyone that has looked at the data will have noted a good visual correlation between WTO data and the CRB Index, and this is only to be expected.  In fact, world trade seems more likely to rise at a pace rather than collapse.  Oh well, panic made a few bucks for the brokers.

The Raff Report is still waiting for the huge increases in metal inventories that some pundits expect.  It amazes the Raff Report that so many analysts actually believe the drivel they write, especially when it comes to making predictions of demand that as any smart analyst knows is possible to measure with any degree of accuracy.  The Northern Hemisphere summer holiday period is almost upon us again, a time when many factories close or reduce output over the break.  This is often a period when terminal market stocks rise and prices soften.  This did not really happen, at least in an overall sense last year, and might not happen this year but it should not surprise if stocks rise and prices exhibit seasonal weakness.

Too bad if you held any stocks in your portfolios with their key assets in Mongolia.  Last Friday night the Mongolian Government voted to introduce a massive hike in taxation of gold and copper when certain price levels are breached.  Nothing like a super profits tax of 68% to scare the daylights out of potential foreign investors.  This might delay development of Ivanhoe Copper’s mine in the Gobi Desert – another potential bull point for copper in a few years time.

Natural Rubber – Problems Ahoy

An early Raff report focussed on the shortage of natural rubber and the implications for the supply of the largest truck tyres that are made mainly from natural rubber.  Natural rubber provides the largest tyres, some weighing over 5 tonnes with the necessary wear and strength characteristics.  If 2005 was anything go by the situation is set to worsen.  Largest tyres will remain difficult to obtain.  The Raff Report has been told that two Russian firms are re-treading large tyres and there are Aussie firms patching tyres pulled from fill or used as barriers and as traffic control devices at mine sites.  Last year the International Rubber Study Group (IRSG) estimates that production increased by 2.4%, lagging demand that grew at a 5.1% pace.  The IRSG reports that the deficit widened in the first few months of 2006. 

The shortages of large tyres should not be underestimated concerning hampering development of large open-pit mines.  It might seem that small mines are not so impacted because small trucks have tyres containing a greater proportion of synthetic rubber.  However, a key input into synthetic rubber is crude oil.  The hike in crude oil impacts the prices of these tyres.  But perhaps of more concern and presumably related to the competing products from refining of crude oil, output of synthetic rubber fell 0.5% in 2005 to 11.97M tonnes.  And then there is the issue of where does the tyre producer get their biggest bang for the buck – truck tyres or car tyres?  The answer seems to be truck tyres since the IRSG reports that production of commercial tyres increased to 159M units in 2005, from 157M units in 2004.  Production of passenger tyres fell from 581M units in 2004 to 578M units in 2005.  Must be the increasing sales of Cooper Tyres that the Raff has found outlasts most other makes by at least 50,000km.

Looking ahead, subject to prevailing weather conditions, the IRSG expects the production of natural rubber to exceed demand by a small margin of 0.3% in 2006, widening to 1.6% in 2007.  The Raff Report hopes that the IRSG is better at estimating demand for rubber, than most metals analysts are for metals.  I am sure that the major miners have paid-up for the latest IRSG industry report and wandering about long-term secure supply of tyres for the large fleets of trucks.

Some of the IRSG data is presented in the following three charts. Not surprisingly the price of natural rubber has risen apace over recent times.   

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