Commodity PricesIt is true that the general consensus is for commodity prices to come down significantly over time. Its a very complicated debate so let me summarize my own view:
1) Commodity prices likely to remain high over the next 3-5 years.
2) Cycles are always longer than people think
3) Commodity prices likely to decline after 5 years, but higher than pre-2000 averages.
Point #1:
I think copper is going to average around US$3.00-US$3.50/lb. this year and next year, maybe settling down to the US$2.50-US$3.00/lb. range 3-5 years out. Worldwide economic growth will continue to keep copper demand growing at 2% per year. Regardless of what happens in the U.S. it is doubtful absolute demand will fall in China or India. There simply isn't enough new growth in production to move prices lower. It doesn't matter that some mines are wildly profitable at US$1.50/lb. copper, the market price is set by the marginal cost producer and an "imbalance" causes "Economic Rent" for the lowest-cost producers.
You have to fight "inertia" thinking. Let's talk about oil for a second. Four years ago oil was US$20/bbl. When ti made its move to US$35/bbl there were hollars of "Peak" and demands that the U.S. release barrels from the Strategic Petroleum Reserve. After another year and oil moving to US$50/bbl, BP was still assessing projects based on US$18/bbl. Think about it today with oil at US$65/bbl. People just 3 years ago crying about sky-high US$35/bbl can only dream it can be that low in the next couple of years. and only now have the majors moved their price deck to assess new projects. Point of this story...it takes a long time for companies and bankers to assume higher commodity prices when assessing projects. Just look at resource calculations today. Tyler Resources just released its resource estimate based on US$1.50/lb. copper. It is this skepticism of sustained commodity prices by companies, but more importantly bankers that provide much of the financing, that will slow the necessary build in production. People can rightfully say: "How do I know commodity prices will be high in 2-4 years, the time it takes to commission a mine?". This skepticism will keep prices high. Only after a few more years of sky-high prices will companies and bankers start to be "looser" in building new projects.
Also note, the "easiest" to find mines have been developed. New deposits don't just grow as we speak. Though we can always find the next super low-cost mine, on average it is logical that deposits will have higher costs than the best of the past. That's one reason why the M&A market is so hot. Better to buy great cash flow now - even paying a huge premium - than to build. You may be paying top dollar, but these commodity prices make payback laughable.
Point #2
Business cycles are always way longer than anybody thinks. The Asian currency crisis was 10 years in the making. When it collapsed, the value of the Thailand stock market in US dollars was down by three-quarters. You would have been correct to call a bubble more than 3 years earlier, but would have gone broke waiting.
Think of the dotcom bubble. Alan Greenspan's famous "irrational exuberance". If you shorted the NASDAQ that day and held on until late 2001 you made money. He was right. But over the two years (an eternity for a stock market investor) the NASDAQ kept going higher and the bubble got bigger. You would have gone broke or cried uncle waiting.
Metal prices were low for 15 years with short-term periodic spikes. Late 1980's until early 2000's. The long-term ROE of the mining industry was dismal. When commodity prices were high in the 1970's it encouraged overinvestment in the sector. when the inflection point hit the rise has been rapid.
Also look at the steel industry. A friggin 20 year decline until 3 years ago. Now steel is one of the most profitable businesses anywhere.
Point #3
With all of the consolidation globally, the main guys control most of the resource base. They are going to be smart. They won't try to overbuild anymore that would cause prices to crash. Combined with the fact that new mines are likely less prolific in general and companies/bankers demanding higher returns on new projects I wouldn't expect copper prices to see much below $2.00/lb. even after 5 years out. It will take 5 if not even 10 years for people to realize commodity prices will be "higher" in order to develop enough projects to bring prices down even to moderately high levels.
The key is this. I love positive option! People so underrate this. What do I mean?
Which would you want to buy?:
1) A company that isn't making much money now, but lots look like they will go right and can make plenty 2-3 years from now; or
2) A company making tons of money with a low valuation because it is assumed the high profits cannot be sustained, yet entering second year of same psyche yet prices remain high.
The sad reality is most people prefer #1 because people psychologically prefer "change" vs. valuation absolutes. But the real smart money and the least risky way to invest is buy companies in #2. How many times companies in #1 flounder because "things changed". Look at steel stocks. Many people said to sell steel stocks last year saying that it was ridiculous and cannot be sustained. If you listened and shorted you would have been in a world of pain.