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    Sunday, June 12, 2005

     

    Recession in the West - Effect on Commodities

    I have spent a lot of time thinking about what effect a recession would have on commodity prices. Most of my investments are in commodity related stocks and a synchronized western economy recession would be expected to reduce commodity prices but by how much.

    Firstly I scoured sources to determine reasonable 2005 copper consumption in Tonnes for China, India and all of Asia. I also found copper consumption growth rates for China and India. (Copper is meant as a proxy for a range of industrial / growth commodities all of which should display similar characteristics). I then built the model in the table below. It assumes that Chinese demand continues at 20%, Indian demand accelerates by 1 percentage point per year, the rest of Asian demand remains constant and that the world ex-Asia reduces it's copper demand by 26% in 2006. These numbers are shown in the growth columns for 2006. As you can see these assumptions lead to a 5% decline in copper consumption. In 2007, if we assume that copper consumption does not grow anywhere but China and India, we are already back to today's copper consumption. So it takes about a year for a 20% decline in World ex-Asia copper demand to be caught up in China's growth (and to a much lesser extent India's growth too).

    So where does the 26% decline in the US and rest of the world come from? Well that's pretty simple, it's about the highest decline in copper consumption in the US since the 40's. Incidentally big declines are usually followed by at least small increases and this model assumes no increase.

    Furthermore it is generally accepted that China is following a path that is leading to increased copper consumption per capita as GDP is rising. This path has an accelerating copper demand for a linear increase in GDP (up to a point). Therefore a fixed 20% increase for China is probably low.

    So even given a very severe recession in the US and the rest of the world ex-Asia, copper demand is likely to bounce back to today's level within 2 years. Many of the stocks I've invested in assume metals prices are going to fall back to their previous low levels (60-70c in copper). It seems EVEN given a severe and long recession in the west, that commodity prices will be higher 3-4 years from now.

    Demand (M Tonnes) China India Rest of Asia USA Rest of WorldTotal

    GrowthGrowthGrowthGrowth Growth% Change
     from 2005
    2005 3,500,000 347,270 3,955,250 4,980,000  3,038,480 15,821,000
    2006 4,200,000 20% 385,47010%  3,955,250 0% 3,685,200-26%  2,248,475 -26% 14,955,504-5%
    2007 5,040,00020% 431,72611% 3,955,2500%  3,685,200 0% 2,248,4750%  15,360,651 -3%
    2008  6,048,000 20% 487,850 12%  3,955,2500%  3,685,200 0% 2,248,4750%  16,424,776 +4%
    2005 % of
    Worldwide Demand
    22% 2% 25% 31%19% 100%
    All Asia 49%


    If you change the model to assume Rest of Asia, US and Rest of World grow demand at 3% (The US long term average) then by 2008, demand will have increased by 25%.

    Chinese and to a lesser extent Indian growth are going to support the price of commodities regardless of the performance of western economies. If there is a western slowdown, the resulting (post recession) recovery is going to push commodity prices to levels well beyond today's.
    Comments:
    Your analysis is fatally flawed. Have you never read _The_Penny_Threshold_? When the US dollar falls to the point where the copper contained in a penny is worth at least USD $0.0125, this will precipitate an unprecedented buy-up of US penny reserves. While this is likely to have a buoyant effect on the US dollar as a side effect, the real effect is going to be a world-wide copper crash as copper becomes essentially free for a short period of time. Canadian and Mexican copper reserves are at highest risk, but there will be a world wide copper crash. It's widely speculated that such a crash would also have disastrous effects on the value of tin, silver, dysprosium and possibly seaborgnium.

    I don't know about you, but as soon as I read the analysis in that book, I shorted copper, longed gold and middled uranium. It seems so obvious now!!
     
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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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