13.   MACRO-ECONOMICS AND COMMODITY PRICES

13.2.1  

Short-term Outlook – twelve months

Following on strong world GDP growth of 4% in 2004, economic expansion proved to be remarkably resilient in 2005, growing at about 3.5%. This, despite record-high oil prices and the impact of major natural disasters, such as the December 2004 Asian tsunamis and some of the worst hurricanes on record in the USA during the second half of the year.

The US and China remained the engines of growth of the world economy, but global growth has broadened significantly since the middle of 2005, with, for example, economic expansion increasing in Japan and Europe due to greater domestic demand strength. Despite significant monetary tightening by some of the major central banks, global monetary conditions remained accommodative, with relatively low real interest rates.

Given the broader base of economic expansion, together with the fact that the pace of growth in the USA and China is expected to decline only moderately, above-trend global economic growth of some 3.4% can again be expected in 2006. Leading economic indicators and surveys of purchasing managers from around the world confirm the view that the global growth momentum will continue in 2006.

Economic expansion in the USA is expected to remain solid in 2006, at about 3.3%, compared to the 3.5% of 2005. Growth in Europe is forecast to be higher in 2006 than in 2005, accelerating from some 1.4% to about 1.9% in the Eurozone. Expectations of economic growth in Japan are similar to those for the Eurozone. In China, the strong growth experienced during the last few years is expected to continue in 2006.

Although the value of the dollar strengthened against the euro in 2005, based on a rising interest rate differential in favour of US assets, it is expected to weaken again in 2006 due to the anticipated increasing US fiscal deficit and trade gap. Oil prices are expected to decline only slowly and to remain well above real long-term historical averages, primarily due to robust demand from China.

The major risks to the global economy remain high oil prices, the world economy’s overdependence on American household spending and the continued reliance of the USA on massive foreign inflows to finance its twin deficits.

13.2.2  

The Role of China

The industrialisation and urbanisation of China is fuelling an extremely rapid pace of economic growth. In 2005 China’s GDP rose by 9.9%, marginally lower than the growth of 10.1% recorded in 2004. The rise in industrial production was even more pronounced, increasing by 16.2% in 2005. This explosive growth is causing considerable strain on China’s infrastructure and has raised concerns surrounding its sustainability. To this end the Chinese Government embarked on a series of measures in 2004 and 2005 designed to slow economic growth to a more manageable pace. These measures primarily focused on limiting investment in fixed assets, notably in the property market and in the steel, cement and aluminium sectors.

The moves to slow China’s booming economy have been successful in part. Nevertheless, GDP, industrial production and fixed asset investment growth remain at elevated levels, with GDP growth above 9% again being forecast for 2006. A major platform for the high investment rate is the fact that China has the capacity to build industrial plants at capital cost estimated to be 30% – 40% lower than western counterparts.

Looking forward, China’s role in the global economy will become increasingly important. The industrialisation and urbanisation of the country will continue at a rapid pace and its export-led growth will be increasingly supplemented with that stemming from consumption by the burgeoning middle-class in the country’s coastal provinces. However, it will also have a negative impact. The attractive low-cost environment provided by China will cause the replacement of considerable amounts of manufacturing capacity in the mature economies and elsewhere in the developing world.

Consumption in China is an increasingly important driver of many commodity markets, fueled by strong materials intensive growth over the last decade or more. In 2004, its share of world market demand for individual commodities such as steel was 27%, iron ore 32%, zinc 23% and copper 20%. Due to the fact that the country is deficient in local resources of many of the commodities which it consumes, it is a major importer of raw materials, to such an extent that demand from China played a major role in the skyrocketing of global dry bulk freight rates in 2003 and 2004.

The dependence of China on imported raw materials has resulted in the Government encouraging large Chinese companies to invest in foreign resource concerns in order to secure a steady supply of natural resources.

The intensity of use of metals and minerals in China lags far behind those of the developed economies of the world and, especially, those of the newly industrialised economies, such as Korea and Taiwan. It is, therefore, possible that strong growth in commodity consumption could continue in the medium to long term. However, it is widely expected that, over time, the commodity intensity of China’s GDP will fall. Nevertheless, even a halving of consumption growth from rates of more than 20% p.a. would still leave a healthy, and more sustainable, rate of expansion in commodity demand.

13.2.3  

Long-term Outlook – ten years

In the longer term, the developed economies of North America, Europe and Asia will remain important consumers of commodities. Economic and commodity demand growth in these countries will, however, be limited by structural problems in their economies and to the relocation of manufacturing industries to China and other developing countries.

In contrast, it is expected that China and other developing economies will play a similar role to that which the USA and Japan did from the early 1930s to the late 1970s in terms of rapid commodity-intensive economic growth, which led to increasing real commodity prices during this period. This was followed by a period of declining real prices from the early 1980s, initiated by the oil price shocks of the 1970s. Obviously, persistently high energy prices could again put a brake on economic expansion world-wide.

Due to the impact of China on raw materials demand, analysts generally expect average real commodity prices to be higher during the next 10 years than those prevailing during the last 10 years. However, the current extremely high prices of, especially, bulk commodities are not expected to be sustainable.