David Prosser's Outlook: That 20-year commodities super-cycle is in need of a puncture repair kit
Wednesday 27 August 2008
The Olympics may have captivated all but the most sports-phobic among us, but Rio Tinto's directors can be forgiven for a sigh of relief that the Games are over. To satisfy the pollution commitments made to Olympics organisers, China had to put the brakes on its speeding economy, suspending manufacturing in Beijing and neighbouring provinces for much of the summer. That's not happy news for Rio, for which China is now the all-important customer.
However, the reaction to Rio's first-half results yesterday suggests the market is worried about the world's second-largest miner, even though China can now put the distraction of the Olympic Games behind it. Soaring profits and the continuing saga of rival BHP Billiton's interest in the company were not enough to prevent a sell-off of its shares.
The reason, of course, is concern about Rio's prospects in an environment of global economic slowdown. Advocates of the 20-year super-cycle of booming commodity markets have gone a little quiet over the past six weeks, as this concern has come to the fore. Not only have commodity markets stopped booming, many have fallen back by 20 per cent since the beginning of July, so they're actually in bear market territory.
Rio Tinto, whose own shares are off by close to 30 per cent since mid-May, urges investors to see past what it hopes will prove to be a short-term blip. Like other proponents of the super-cycle, Rio argues that demand for its products far outstrips supply. The logic of the commodity bulls is that demand is soaring thanks to the vast appetite for raw materials from the new global powerhouses – in particular, China. And because, for many years, prices were too low to encourage much in the way of exploration, supply for now remains limited. Ergo, commodity prices will keep rising.
Rio's own economic models predict 4 per cent global economic growth in 2009, with a 9 per cent increase in the size of the Chinese economy. The miner may be right, but there's a growing number of super-cycle sceptics who think such forecasts are about as accurate as the ones to which the Treasury is currently clinging for the UK economy. Not very, that is.
They have a point. In the past, central bankers around the world have acted in the same way when confronted by threats to economic growth, relaxing monetary policy in order to keep the show on the road. But these relaxations – and they have been at least partly responsible for the super-cycle getting started – are not such an easy option this time around. Indeed, many central banks are now more concerned about inflationary pressures than falling levels of growth.
The People's Bank of China is no exception. It has made a series of attempts over the past 18 months to get on top of inflation, culminating in a pledge from its governor in June that it would crack the problem. Its chief tactic has been to tighten the money supply, while other central banks – including those in India, Brazil and the eurozone – have focused on interest rate policy, but the effect has been the same: a slowdown.
Such has been the Chinese determination to get on top of inflation, the central bank has accepted a collapse on the Shanghai stock market as an unfortunate side effect of the battle. China's economy may not pick up quite as quickly, post-Olympics, as Rio hopes.
Not that the country, in any case, operates in a vacuum. Urbanisation and modernisation are only part of the economic success story – China also depends on demand for its exports, particularly from the US and western Europe. With these markets in decline, that demand is bound to fall back.
So much for the super-cycle, which in truth always sounded rather too good to be true. In a bull market, it is never difficult to find someone to explain why soaring prices are part of a sustainable paradigm shift, rather than a bubble that is bound to burst. Like so many before it, Rio may be about to discover that the world hasn't really changed after all.
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