Comment: Market conditions good for natural resources

The world's natural resources industries are enjoying the best market conditions for a generation, according to Merrill Lynch Investment Managers (MLIM).


Strong global demand, coupled with supply constraints, has boosted several sectors including gold, mining and energy.


Although the gold price has hit a 16-year high in US dollar terms the industry is still facing strong demand for jewellery (up 19 per cent in the first quarter of 2005 v Q1 2004), from retail investment (up 21 per cent in the first quarter of 2005) and from exchange traded funds (ETF) which now soak up nearly 10 per cent of annual gold production. But the supply of gold is limited. Last year gold production declined 4 per cent, the largest annual decline since the 1940s and Central Bank sales were down nearly 20 per cent. Gold mining companies' exploration budgets have been falling for years, down 76 per cent compared to 1998. 


In the mining industry as a whole, company results in the first half of 2005 were even better than the good results of 2004 and signs for 2006 are very encouraging.


Here again demand is very strong and likely to continue so, largely driven by the industrialisation and urbanisation of China which is fast becoming the largest consumer of raw materials in the world.  It is estimated that China will consume around 40 per cent of the world's iron ore production in 2005, in 1990 that figure was below 20 per cent.


Graham Birch, Head of Natural Resources at MLIM, commented: "The market is wrestling with the question, 'Is this the peak of a normal commodities cycle or the early stages of a super cycle?' Time will tell but the arguments for a super cycle are persuasive -- the emergence of two huge new markets represented by the industrialisation of China and India. Set against this, supply is constrained by the lack of investment in the previous decade and the long lead times needed to increase production. And consolidation in the industry is leading to the hope that management teams have learned from past mistakes, will not overspend to increase production dramatically but will be satisfied with a new era of moderate supply growth."


In energy the world's thirst for oil shows no sign of abating. Oil demand increased 3.6 per cent in 2004 due to demand from the US and Asia.  It is estimated that oil demand will increase by 1.9 per cent this year (source IEA) and 2.1 per cent in 2006. On the supply side there is very little slack in the system.


OPEC's effective spare capacity has reduced dramatically and the oil majors are struggling to grow their production at the same time as their existing oil basins are maturing.


Added to this the industry faces frequent supply disruptions in Iraq, Nigeria, Venezuela and most recently the Gulf of Mexico and project delays such as those seen in West Africa, the former Soviet Union and the Middle East.


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