METALS COST INFLATION
has been demonstrated in many commodity- linked currencies and,
3) The difficulty in managing the volatility of currency swings as monetary policy is used in extreme ways in an attempt to solve global growth challenges.
Figure 3 shows the CRB Reuters/Jefferies commodities
index from 2000, in USD and AUD terms. Despite impressive commodity performance over the past decade, a decade which has seen the emergence of China as a major source of structural demand, we see that commodity performance differs significantly depending on the currency that it is valued in. Given the strength of commodity-linked currencies such as the AUD, which has appreciated over 100% (6.7% per annum) since early 2002, it seems clear that much of the appreciation of commodities is due to the depreciation of the USD.
Figure 3: Currency Can Make or Break Profitability
100 150 200 250 300
50
CRB Reuters/JefferiesCommodityIndex CRB Index(AUD)
currency values and ultimately results in a natural rebalancing effect, with returns ultimately regressing back to a more ‘normal’ level thereby disincentivising further capital inflows. There has been another structural element in
currency markets however, which has also had an inflationary impact for both commodities and many currencies and that has been the decline of the US dollar. The question is whether this downtrend will continue. The dollar’s underperformance vis-á-vis other
currencies has been a natural consequence of excess supply relative to demand: Americans have been spending on imported goods with greater enthusiasm than foreign purchases of American bonds. Interestingly, despite high debt levels, US dollars are also seen as a safe-haven during times of elevated risk thus lending support over the past several years despite a surge in debt levels. One could, however, make the case
for a structural reversal in the dollar. That with the dramatic shift in energy availability within the US and the potential improvement competitive position of US industry vs. global competitors, the dollar is poised for a period of structural strength. Figure 4 illustrates the change in energy fortunes for the US over the past several years. Effectively this means that there are less US dollars flowing out of the country to buy foreign oil/energy. However one needs to observe the entire
Sources: Bloomberg Financial LP, Deutsche Bank
Currencies: Structural Considerations There are significant cyclical elements that lead
to swings in currency values, leading to temporarily distortions in costs. Classically, during the early stages of the business cycle, anticipation of recovering growth leads to stronger commodity prices and in most casts a coincident increase in the value of commodity-linked currencies (AUD, BRL, CAD, etc.). On the other hand slowing growth or recession leads to falling values.
The aging of the world’s resources combined
with the recent elevation of prices has resulted in a significant ramping-up of industry costs
Over the past 10 years there has been a structural bull
market in metals. This has resulted in similar strength in commodity-linked currencies as capital flows are attracted to these regions. Capital inflows push up
68 June 2012
picture. Is there still the same demand for US dollars? While we expect that the trade balance for the US may become less negative, the trade surplus for China may become less positive. This may be
important because China has been a key buyer of US dollars. As China generates less revenue from exports they are likely to be buying fewer dollars. On this basis the case for arguing for a reversal in the
structural decline of the dollar becomes less obvious. We continue to believe that the dollar will remain under pressure resulting in supported commodity prices in dollar terms and continued cost pressure for producers.
Geology (Resource Quality) One of the most important elements in differentiating
value in the resource industry we believe is the relative quality of the resource being exploited. Higher quality effectively means less work: less energy to mine and process, less manpower, less consumables, less waste and lower capital intensity (although offset to a degree by higher taxes). It also usually means a faster pay- back period which translates into lower operating/ political risk exposure.
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