Resources on course for further growth

Clive Donner

My message is essentially that resources sector growth is far from over.

As we have seen over the past three years or so, the resources sector has immense fundamentals, which will serve to drive its growth.

Commodity prices are driven by the outlook on global economic growth, as well as the impact of developing economies, current stockpile levels and sector investment.

In terms of global growth, the expansion of industrial production continues above trend.

If you look at the 35 years from 1970 to now, we can see the trend is up. Who are the culprits? The past five years China and India in particular have been growing at 9 to 10 per cent, and there has also been growth of 4 to 5 per cent in other Asian economies, and in the newly industrialised countries (NIE).

China and India account for over 50 per cent of world gross domestic product (GDP) currently, and over 60 per cent of the growth in world GDP.

This has resulted in an increase in appetite for commodities.

Currently, US and China are clear leaders in absolute GDP growth in US$ billions, according to the IMF’s “World Economic Outlook” survey for [September 2006].

But if you look at China’s position in 2015, which is not that far away, it’s ranked as number one on the survey. In fact, at that point in time it is expected to be as large in GDP in absolute terms as the US and China are today.

The urbanisation that the Chinese are embarking on is a very large project indeed. It will take 20 to 25 years.

They are building the equivalent of another US by migrating 300 million people from rural and northern China to the south and coastline.

China is a key driver in the growth of the world’s metal consumption, contributing around 50 per cent of the growth demand for base metal.

Its contribution in terms of lead, nickel, steel, tin and zinc is nothing short of extraordinary. For example, China’s contribution to the growth in demand for lead was 40 per cent for the 10 years to 2002 — and 110 per cent in the past three years!

It’s not likely you can turn that growth rate off simplistically, as a consequence of the urbanisation and other factors taking place in China and elsewhere in Asia, as well as in the newly industrialising countries (NIEs).

China currently accounts for about 30 per cent of base metal consumption (and the US about 20 per cent). The predictions are that China’s consumption of iron ore, for example, could be 60 to 70 per cent of global demand or consumption of that metal, and 50 or 55 per cent of zinc and steel.

Commodity prices are, of course, also driven by supply, and exploration activities are part of that supply chain. Essentially, we’ve seen very few discoveries in the past decade globally, which has impacted the supply of metals.

Also, it takes up to a decade to get any new mines on-stream from exploration through to production.

Even emerging countries now have environmental standards and approval processes that make it difficult to get these mines up and running.

Stockpile levels are the second major factor on the supply side, and they are at critically low levels now in nickel, lead, copper and zinc - the four key LME metals — due to increasing consumption and limited supply coming online.

Finally, resource sector investment is growing as institutional investors look for increased diversification and an attractive risk/reward profile. If you look at the commodity index funds alone in 2005, $80 billion was invested.

In summary, the sector fundamentals remain strong and resources and commodity prices will remain ‘stronger for longer’, as the saying goes.

The lack of supply and exploration and stockpile levels is a critical factor. We can expect further growth, strong earnings and more corporate activity in the sector.

Along the way, we are obviously going to get consolidation points, not just in markets, but in commodity prices as well. But that’s healthy for the sector.

Clive Donner is the the managing director of LinQ Resources Fund.