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China vs. the US, Merrill vs. UBS

Will a US recession tip the entire metals complex, including Gold Prices, sharply lower in 2008...?

ADD THE falling US Dollar to rosy growth forecasts from China and what do you get?

   If you guessed higher commodity prices, you get a gold star. Yet among the big investment institutions, there's mixed opinion about what metals prices will do in 2008.

Merrill Lynch says that a recession in the US and even more subprime trouble cannot possibly derail the commodity super cycle. Dow Jones quotes Merrill's latest research report thus:

"For the mining sector, US demand is becoming less relevant, as China consumes two to four times more metal and comprises close to 75-100% of demand growth for many commodities."

Ah yes...China. We've reported in The Daily Reckoning before that despite its mind-boggling appetite for base metals, China may actually just now be entering its most metals-intensive phase of growth. That suggests the case for increasing production is pretty strong, which puts all the proposed mining-stock mergers in context.

Merrill also said, "While we don't believe the Fed will allow the US to go into a recession, if it did, we believe that this would only impact Chinese demand at the margin."

Two bold statements for the price of one!

If the economy wants to go into recession, it will. The Fed can fight slower growth by making credit more widely available. And you can lead a horse to water...but the trouble with using interest rates to rev the economic engine is that it doesn't always work. People borrow when they feel confident...or reckless. When their frame of mind changes, not even an economic incentive to borrow can overcome the psychological wariness of taking on new liabilities.

That's the theory anyway. A lot of traders have lost money in the last few years thinking consumers have finally reached their breaking point. So we'll see.

And what about Merrill's other statement that an American recession will only affect Chinese metals demand "at the margin". This is obviously what Australian resource producers are hoping. But is it true. Will China keep buying Aussie ores and metals and coal right through a US recession?

It may not be as simple as that. That is, you might start to see some divergence in the performance of various metals. The entire asset class may not behave the same way. And really, why should it?

Metals prices – not least the Gold Price – are partly driven by the fall in the US Dollar and partly by growing Chinese demand. But the picture on the supply side is more complicated. Supply of metals is scattered all over the earth, with some countries being critical to certain metals.

Gold Bullion, for instance, is mined most heavily in South Africa (where output has halved in the last decade). The United States has just been overtaken as a gold producer by China itself, and now China looks set to overtake the No.1.

But focusing on base metals, this variation in the location of production may begin to account for slightly divergent metals prices in 2008, some moving higher, some moving less high, and some not moving at all, or even moving lower.

UBS released a report yesterday that's bullish on copper and aluminum, but not so much on other metals. USB's Joachim Clement told journalists, "We feel the imposition of export taxes by China, one of the largest producers and consumers of base metals, to restrain the increasing prices and cool its rapidly expanding economy, could be the pivotal drivers of prices in 2008. This development may be particularly favorable for aluminum and copper."

UBS says copper prices could outperform in 2008 thanks to a surge in imports of refined copper, plus a 23% increase in Chinese copper usage in 2007. It's forecast to rise a further 6% in 2008.

"UBS also anticipates that the present tightness in the concentrate markets may continue as low treatment and refining charges may result in reduced smelter output next year," reports Mineweb's Dorothy Kosich.

"Another crucial factor which is likely to come into the picture on further dips in prices is buying interest from the Chinese State Reserve Bureau as it seeks to replenish inventories," Klement also stated. Production outages may put a floor under copper prices, too, he said.

What's UBS bearish on? Lead, nickel, and zinc. The reports mentions new zinc smelters in China coming on line in 2008 to keep that market well-supplied (and prices contained). UBS says demand from stainless steel producers will stay weak in 2008, keeping a lid on nickel prices.

So who's right – Merrill or UBS? Well, Merrill is probably right that iron ore prices are going up at least 40%. Aluminum and copper are up in the air. Falling US industrial production or a recession, you'd think, would dent demand.

But then there's China.

In short, a blanket buy policy on base metals producers is probably not a good idea for investors in 2008. Sorting out the various trends among the metals will be needed – and the trends driving world Gold Prices don't all apply to industrial metals.

Of course, maybe all metals will fall together in unison on a global recession and none of this splitting hairs will matter. But somehow we doubt it – and so we'll continue to split hairs regardless, and let you know what we've found.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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