Lynley Donnelly investigates the reasons behind the quadrupling of the prices of commodities.
If you are a commodity and your price hasn’t quadrupled over the last five years, you are, quite simply, not the real thing.
Most analysts would agree that this is fair assessment of the rise in value of the raw materials surfing the wave of the “commodities boom”.
For many who don’t speak economese though, fluctuations in the price of coal and iron ore are the affairs of men with the word “financial” or “analyst” somewhere in their job title.
But with the recent spike in oil prices on the back of rising prices of almost all other commodities, people at every level of society have had to adjust their lifestyle to cope.
Breakfast, a shirt, the trip to work, a house, electricity—all have swiftly become more expensive or simply out of reach for the average Joe.
But what has spurred this global economic shift? When did it start, what is being traded and what does this mean for South African companies that are key commodity players?
Loosely, commodity is anything that trades based on the laws of supply and demand, and is usually a raw material physically required to produce an end product. Think maize for foodstuffs, for example, or iron ore needed to make steel, or perhaps the most familiar—crude oil, for refined fuels like petrol and diesel.
What is generically termed “the commodities boom” describes the rapid rise in prices of commodities like minerals, metals, agricultural goods and energy commodities like oil and gas.
The bottom of the commodity cycle came around late-2001 and early 2002. From then on, a steady rise in the price of commodities began, largely on the back of huge demand from developing economies like China and India.
China is in fact pivotal to the commodities boom. The rapid urbanisation of the more than billion-strong nation and its increased openness to international trade has ensured that the world’s supply of raw materials become the roads, buildings and fuel for a country that in turn manufactures a huge portion of the globe’s consumable products.
One sector, mining, is associated with commodities more than any other.
Both small regional operations and global diversified mining companies have seen massive returns as global economic growth swallows up the metals and minerals mined out of the earth.
What is traditionally a risky business, particularly when commodity prices are low, has seen a boom in trade.
According to a report by auditing firm PricewaterhouseCoopers (PwC) which examines the global mining industry, the sector increased its market capitalisation (value) by 54% in 2007. The report, which looked at the top 40 global companies, states that net profits for the global industry were 20 times higher than they were in 2003, at the start of the commodities upswing.
Globally, the top 40 mining companies increased their total market capitalisation from $332-billion in 2003 to $1 388-billion in 2007.
The top three mining companies in the world are BHP Billiton, Rio Tinto and Vale, all large diversified companies that operate in locations across the planet.
Since 2003 BHP Billiton’s market capitalisation has grown from just over $50-billion to more than $180-billion, while Brazil-based Vale, third largest, has gone from a 2003 market capitalisation of a few billion to almost $150-billion.
Four new players from developing countries have entered the list of the top 10 mining houses, the report says. These include Brazil’s Vale and China’s state-owned energy and mining company Shenhua. Their entry points to the increasingly dominant role developing economies are playing in the competition for natural resources.
It is significant that only one gold miner, Barrick Gold, makes it on to the list, as gold is the one commodity that has not enjoyed the same rate of success as counterparts like copper.
According to the PwC report, the top commodity performer is copper. It accounted for a total of 28% of all revenue generated by the top 40 companies.
One analyst has observed that the average copper price in 2002 sat at $1 559 a ton. In 2007 that price soared to an average of $7 121 a ton, a fourfold increase. Copper is chiefly used in plumbing and electrical applications. But with countries like China laying the equivalent infrastructure of two Eksoms a year, it is no wonder that copper is an increasingly precious resource.
The country also reportedly intends to erect some 40 000 or so skyscrapers between now and 2025. Imagine the electrical wiring and copper plumbing that will be utilised at that level of construction.
Iron ore and manganese are another two good performers, due chiefly to the fact that both products are feedstock for steel. The creation of any infrastructure requires steel at some level.
Using the Hammersly Fines price, the Australian benchmark for iron ore, iron was trading at 28 USc per dry metric ton unit in 2002. The current average is 129 USc per dry metric ton unit. Manganese, in the meantime, has risen from around $1,99 a ton to an average of $3,53 a ton, an increase of about 130%.
And of course, one can’t leave out oil. A barrel of brent crude cost about $25 in 2002, while in 2007 it averaged a price of $73 a barrel, with a current spot price of around $106 a barrel.
Gold has surprisingly not been a huge winner in the boom. While it accounted for 9% of the top 40 companies’ revenue, its price has merely doubled since 2002.
But deep-level gold mining is exceedingly expensive, and while expenditure has gone up because of rocketing fuel and production costs, gold prices have increased rather wanly in comparison, leaving margins rather tight.
Another factor has been that, by and large, gold is not an industrial metal. It is not as necessary for building programmes as other metals are.
And since many banks and investors shore up gold reserves, there are greater stockpiles of the stuff. Metals like copper have critically low stock levels.
The PwC report also points to the good performance of coking coal, also used in steel manufacturing. Measuring market capitalisation by commodity, the report points out that coal has increased its market capitalisation to more than 10% in 2007.
The local money makers
Locally listed companies that have performed well on the back of the boom are South Africa’s diversified mining houses. These include multi-nationals like BHP Billiton and Anlgo American, but also local ventures like African Rainbow Minerals (ARM).
According to the Financial Mail‘s Top Companies 2008, ARM shares have outperformed even BHP Billiton’s in the past two years.
Nevertheless, in the financial year ending June 30 2004, Billiton’s profits sat at $3,5-billion with an EBIT (earnings before interest and tax) margin of 27%. In 2008 these figures rose to R15-billion and 48% respectively.
The EBIT margin calculates a company’s revenue minus its operating costs. It is a good indication of where commodity prices sit in relation to the cost of mining those commodities from the ground.
Similarly for Anglo American, profits in 2003 sat at $1,6-billion, with an EBIT margin of 12%. In 2007 profits had risen to $5,7-billion and the EBIT margin to 31%.
While figures for ARM are only available from 2006, the company has performed exceedingly well in two years. Profits two years ago stood at R462-million with an EBIT margin of 24%, while 2008 saw the figures increase to R4-billion and 50% respectively.