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Is there life after the "supercycle"?: Andy Home

US-COLUMN-HOME-COMMODITIES-BOOM:Is there life after the "supercycle"?: Andy Home

(Andy Home is a Reuters columnist. The opinions expressed are his own)

By Andy Home

LONDON (Reuters) - It has fallen on Marius Kloppers, head of BHP Billiton , one of the world's largest resource giants, to write the obituary of the commodities "supercycle".

"Over the past decade I think many have almost forgotten about the cyclical nature of our business," Kloppers said in a speech given to the Brisbane Mining Club and available on the company's website.

That decade was characterized by "unprecedented" demand growth from China coupled with "a substantial supply lag" across the industrial commodities spectrum.

The result was an explosion in prices, close to 1000 percent for iron ore, more than 700 percent for coal and over 600 percent for copper.

Now, however, Kloppers argued, Chinese growth is slowing as the country's economy transitions away from its previous infrastructure-heavy boom phase and the supply gap is closing.

The record prices will not be repeated. "What we can instead expect is demand growth at more predictable and sustainable levels and more moderated pricing", according to Kloppers.

WHOSE SUPERCYCLE?

Not that Kloppers need be too worried.

Even as Chinese steel intensity moderates, the country will still require rising volumes of iron ore and coking coal.

BHP expects the global iron ore market to grow by 650 million tonnes over the current decade. Not as much as the 800-million tonne expansion over the last decade, but, as Kloppers pointed out, "still a very substantial opportunity".

Particularly for those sitting at the bottom end of the cost curve.

This is why both BHP Billiton and Rio Tinto are still pumping money into Western Australia to lift iron ore production over the coming years.

The extraordinary margins earned when iron ore spiked up to $185 per tonne at the start of 2011 may not be repeated. But earnings for those companies that, again to quote Kloppers, "can supply competitively and at low cost", will prove resilient.

In other words, for the likes of BHP Billiton and Rio the "supercycle" will continue, just not in such a "super" way.

But then, it all depends on what you understood by the "supercycle" in the first place, a point made by analysts at CRU in one of the more thought-provoking presentations during this year's LME Week.

Ask, for example, a copper smelter about the "supercycle" and you'll likely be met with incomprehension.

Copper prices may have boomed over the last decade but copper smelters have seen their margins steadily squeezed between a shortage of raw materials and increased competition caused by China's rapid build-out of smelting capacity.

Or ask an aluminum producer. China's ramp-up of smelter capacity over the last few years has been extraordinary, dashing any prospect of the "supercycle" translating into increased demand for imported units.

For such players the "supercycle" was something that was happening to someone else.

Particularly the high-cost producers incentivized to bring on extra supply to help fill the supply gap caused by what Kloppers called China's "demand shock."

Marginal producers across a range of commodities owe their very existence to the "supercycle". Its passing may well prove an existential problem for many.

LEARNING TO LIVE WITH SURPLUS

If there is a single dominant theme at this year's annual gathering of the metals industry in London for LME Week, it is the likely post "supercycle" landscape.

One where Chinese growth is "only" 7-8 percent per year and one where supply has largely caught up with that growth rate.

Arguably, markets such as aluminum never experienced a supply gap in the first place.

Others, such as nickel, certainly did but have now shifted to structural surplus.

The new, more sober mood was encapsulated in Goldman Sachs' downgrade of its base metals price forecasts.

Aluminum, nickel and zinc price projections have all been lowered on a three-month, six-month and one-year basis.

So has that the bank's 12-month view of copper, although, like many others, it is sticking to its call that copper can still move higher over a shorter timeframe.

Copper supply is finally starting to close the gap on demand but visible stocks are still sufficiently low and the supply-chain sufficiently unpredictable to allow a potential "supercycle" postscript.

A similar case might be made for tin and lead, the latter attracting a lot of interest right now because of the supply pressures building at the scrap stage.

But in broad-brush terms the LME trading community is preparing for a world of more modest growth and more modest price performance.

Sure, there will be plenty of volatility occasioned by the twin macro dramas of U.S. "fiscal cliff" and eurozone "crisis".

And sure, there will be some upside to come from an expected end to the current Chinese de-stocking cycle, one cycle that will assuredly not be going away any time soon.

But a repeat of the last years' price highs looks unlikely given the shift in several markets to sustained supply surplus.

SUPER PREMIUMS

That said, this will be no return to the "status quo ante" for many of the base metals.

Just as the "supercycle" changed the pricing rules for deficit markets such as copper, quantitative easing and zero interest rates have rewritten the rule-book for surplus markets.

Commodity markets in surplus have always required investors to act counter-cyclically and buy when everyone else wanted to sell.

But financing surplus stocks has been transformed from a necessary evil to a significant revenue generator in a time of evaporating returns in more conventional asset classes such as government bonds.

The resulting surge of investment interest in financing aluminum stocks has both almost crippled parts of the LME's warehouse network and forced a disconnect between futures and physical markets.

No-one has particularly high hopes for the aluminum price over the next year or so. But when it comes to physical aluminum premiums, no-one is prepared to call the top.

That uncertainty is in turn causing a step-change in how the industry trades physical premiums.

UC RUSAL, the world's biggest producer of the light metal, said it will shift from fixed to floating premiums for next year's sales.

Others will surely follow and it is only a matter of time before a new generation of aluminum swaps arrives to meet industrial demand for a way to hedge the increasing physical component of the real-world aluminum price.

Zinc looks set for a similar evolution, high LME stocks fuelling the forward-curve contango that is the building block for the cash-and-carry financing trade.

The resulting squeeze on readily-accessible units has implications both for nearby time spreads and for physical premiums as manufacturers compete directly with investors for availability.

So, while the "supercycle" for industrial metals prices may be over, that for physical premiums may just have started.

The main beneficiaries of this "super premium cycle" will be the merchants and the warehousers. Which presumably is why so many of the former have bought so many of the latter over the last couple of years.

(Editing by William Hardy)

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