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Australia: Not Good News From Commodity Forecast

30 January 2009 @ 10:15 pm AEST

There's some not so good news for Australia contained in the latest gloomy world economic forecast from the International Monetary Fund: The growth has gone out of prices for energy, metals and food exports over the next five years and anyone expecting a return to the halcyon days of 2008 had better think again.

That's not to say the forecast is all gloomy: there is a silver lining in there for the well managed company, such as BHP Billiton which reports its 2008 December half year result next week.

We had the bad news in the production report and the closure of the Ravensthorpe nickel mine in Western Australia at a cost of more than $4 billion. Other operations are under review.

BHP's announcement will come in the wake of an announcement from Swiss mining giant, Xstrata of a $US6 billion cash issue to repair its battered balance sheet, and increasing suggestions that Rio Tinto is talking to major shareholder, Chinalco, about some asset sales.

Rio's 2008 results come February 12 and will hopefully provide answers about asset sales, capital raisings and asset value write-downs.

But these deals, like the job losses, mine closures and production curtailments that companies large and small are pushing through at the moment, are merely a form of right sizing from the heady days of last year.

The graph in the IMF forecast projects the Fund's estimates for metal prices out to 2014: the story contained is unpleasant for many in the industry and those who believe the boom will return.

Last year's spike in oil, metals and to a lesser extent, food prices, won't be repeated and prices (expressed as an index) will only have recovered levels seen in the sell-off at the end of last year and in the early months of 2009. On a more even plane, prices will settle around 2007 levels from around 2011 onwards.

That will involve more cost containment and production re-shaping to meet lower levels of demand, even from China, over that time.

It's a gloomy forecast for commodity prices which have powered our economy for the last five years.

"Despite production cutbacks and geopolitical tensions, oil prices have declined by over 60 percent since their peak in July 2008, although they remain higher in real terms than during the 1990, the Fund said in its forecast.

"The IMF's baseline petroleum price projection has been revised down to $US50 a barrel for 2009 and $US60 a barrel for 2010 (from $US68 and $US78, respectively, in the November WEO Update), and risks to this projection are on the downside.

"Metals and food prices have also been marked down in line with recent developments.

"These price declines have dampened growth prospects for a number of commodity-exporting economies."

It is the only graph in the forecast that projects estimates past this year. The IMF's forecasts for growth, prices and government spending stop at 2010.

Looked at another way, the IMF seems to be suggesting it sees no surge in demand levels for commodities, and therefore, aggregate levels of demand in the global economy, for at least the next five years. Any increase will be modest and slow.

Demand will rise in 2010: the fund estimated that "Global growth in 2009 is expected to fall to 0.50% when measured in terms of purchasing power parity and to turn negative when measured in terms of market exchange rates

"This represents a downward revision of about 1.75 percentage points from the November 2008 WEO Update.

"Helped by continued efforts to ease credit strains as well as expansionary fiscal and monetary policies, the global economy is projected to experience a gradual recovery in 2010, with growth picking up to 3%.

"However, the outlook is highly uncertain, and the timing and pace of the recovery depend critically on strong policy actions."

But the recovery in demand is likely to flatten out in 2011-12 and then meander along for a couple years.

It's as much an admission by the IMF that the destruction in demand, funds, confidence and everything else that goes to help economies grow, will have been so vast as to inhibit the pace of the recovery for some years to come.

While our major markets in the advanced countries, like Japan, South Korea, the UK, New Zealand and parts of Europe are recessed, growth in our fastest growing export destinations, like China and India is forecast to ease, but still be positive (6.7% for China, 5.1% for India).

But our export/commodity boom was achieved when Chinese growth was around 10%-13% and India's was above 8.5%.

The IMF comments :

"Growth in emerging and developing economies is expected to slow sharply from 6.25% in 2008 to 3.25% in 2009, under the drag of falling export demand and financing, lower commodity prices, and much tighter external financing constraints (especially for economies with large external imbalances).

"Stronger economic frameworks in many emerging economies have provided more room for policy support to growth than in the past, helping to cushion the impact of this unprecedented external shock.

"Accordingly, although these economies will experience serious slowdowns, their growth is projected to remain at or above rates seen during previous global downturns."

But any improvement won't see a return to the boom and super-boom like conditions seen in the years leading up to 2007-08 and the heady days of 96% rises in iron ore prices, a doubling and more in oil and gas prices and a trebling in the price of some of our coal exports.

The IMF is forecasting a return to subdued 'normality' for the global economy and commodity prices.

That means our old bugbears of a current account deficit; budget deficit and indifferent trade performance will confront us as major restrictions on future growth, and on what governments can do.

The IMF forecast on commodity prices is only the Fund's estimate (and probably influenced by the 'hangover effect') after last year's boom and the present bust.

But it should be considered by anyone looking for a strong rebound here once world economic activity shows signs of recovery.

Companies will have to convince sceptical investors that they are containing costs, keeping production under control and any increases in capacity are covered by rock hard contracts.

It's why reports from the likes of BHP Billiton next week will be crucial for investor sentiment towards this sector.


Information provided to you by the Australasian Investment Review (AIR).
AIR publishes a weekly magazine. Subscriptions are free at www.aireview.com.au.

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