Commodities – will the upward price trend continue in the short and the long term?

Commodities have enjoyed a steady positive ride recently, with a long period of rising prices. The question on all investors’ minds is, will it continue?

Whilst concerns persist over the slowdown in the US, we believe that short-term commodity demand growth will remain stronger than expected because development in Asia, and infrastructure spending generally, will remain high, even if consumer spending slows in the US.

Over the longer term we also believe that commodity prices will continue to move upwards. During the 1950s and 1960s, commodities enjoyed high average rates of demand growth and over the next 15 years, we expect to see a similar scenario, underpinned by three key factors:

Firstly, demand will be driven by the development and urbanisation of economies like China and India.

Secondly, in the Western world, poor economic performance and privatisation from the mid 1970s to the mid 1990s caused 20 years of underinvestment and a need to rebuild existing crumbling infrastructure. This means that commodities cannot fail to be in demand as infrastructure is renewed.

Thirdly, we are seeing increasing investment in new infrastructure for alternative energy sources. Massive investment is also needed to conserve energy for environmental reasons.

Supply will react to the higher prices that we are currently seeing in many commodity sectors, but the speed of this reaction will differ for each commodity. And with high rates of demand growth, periods of surplus output and weaker prices are likely to be short-lived. The outlook does vary by commodity, however. Below we have summarised our views on the main commodity categories.

For base metals, we expect to see flat or falling prices in the short term. At a time when rapid supply increases have been forecast, weaker demand growth from the developed world will spark concerns over large surpluses. But for copper, lead, tin and aluminium, continued strong demand growth from the Middle East, China, and other Asian countries will fuel a recovery in prices before this year is out, as will delays to new supply and disruption to existing supply.

In contrast, the outlook for bulks remains robust as demand for steel and raw materials for steelmaking is dominated by China and the developing world. In addition, destocking of steel in 2007 has left markets tight in North America and Europe. In iron ore and coking coal, spot prices are up to 100% higher than current contract prices, which are forecast to rise at least 50% for the year beginning April 2008.

Meanwhile, energy prices are now settling at high levels as robust demand is sustained, not least because of subsidised prices in many developing countries. Supply, though, continues to disappoint, with non-OPEC countries failing to deliver increases as forecast and OPEC itself reluctant to increase output too rapidly. Thermal coal prices have also risen rapidly as rail and port bottlenecks in Australia have disrupted supplies, and demand for coal in China remains particularly strong.

The outlook for gold continues to look strong with dollar weakness, inflation concerns, falling mine supply, and political and financial instability all supporting the case for higher prices. For platinum, the key driver in the short term is supply, which is being squeezed in an already tight market by safety and cost issues in South Africa. Although car production is likely to decline in the Western world, this will be offset by growth in developing economies and higher emissions standards.

Prices for soft commodities have rallied strongly in recent months and look set to remain firm as demand for biofuels remains strong, driven by government regulation as much as high energy prices. With agricultural land in short supply as a result, crop rotation will be high and prices volatile, but fertiliser demand is very strong and supply is constrained due to lack of investment in recent years.