VIEW's 2004 Predictions

Agree with the statement made here that China will continue to grow despite its government's attempted to subdue its growth. Maybe in the third quarter this will change.


Roar Material?

This rally could persist. And how now, mad cow?
By NICHOLAS ELLIOTT

MORE COMPANIES ARE LIKELY to join DuPont, Kimberly-Clark and Union Pacific in 2004 in finding rising commodity prices nibbling at earnings.

The bull run in commodities, to multi-year highs in some cases, isn't likely to crumble. The potent cocktail of U.S. and Chinese economic expansion and a sliding dollar should keep pouring fuel on the rally, some analysts say.

But the consensus fractures when it comes to what individual sectors -- particularly energy -- will do. At Chicago brokerage firm Alaron Trading, analysts are making a universally bullish call. Says Alaron's Phil Flynn: "What's happening in energy is a microcosm of the commodity markets in general," with demand outpacing supply. He expects crude to hit $40 a barrel next year, up from a little above $30 now, and natural gas to reach $13 per million British thermal units, about double its recent level.

But others are wary of an overswelling supply. Goldman Sachs recently warned that, "The key risk for commodities going forward remains the energy outlook, which continues to be skewed to the downside." Bart Melek, an economist at CIBC in Toronto, sees Iraqi oil production (currently around 2 million barrels a day) probably rising to 2.8 million barrels a day in 2004 and Russian output (now around 8.76 million barrels a day) expanding by 700,000 barrels -- and he doubts that growth in demand will keep up.

The Organization of Petroleum Exporting Countries (OPEC) should be prepared to take a market-share cut, he says, at a time when non-OPEC output is growing. But he doubts that this will happen. Non-OPEC producers will only be willing to cut output if there's "some sort of market coercion," in the form of lower prices. CIBC projects an average crude oil price of $24 for 2004.

Copper, however, could be a winner in an economic recovery. "We're getting to the point where supply isn't going to keep up with demand," says Melek. Inventories have been declining, and although Chilean state producer Codelco has 200,000 metric tons stockpiled, it's saying it won't sell the metal soon -- despite the recent price surge.

The key to the rally in copper, and gains in other commodities, too, has been China's robust economic expansion and its manufacturing and infrastructure investment. But can China's economy keep surging? "We're not looking for a big dropoff in China," and "a lot of the slack is going to be taken up by the rest of Asia and a recovering Europe," says Tim O'Neill, chief economist at BMO Financial Group. China's gross domestic product growth won't continue to grow at this year's 8.7% clip. But any dropoff won't be drastic; he expects GDP growth to come in at 8.2% in 2004 and 7.5% in 2005.

And CIBC's Melek says that, even if there's a decline in China's cyclical demand for metals used in manufacturing, the nation's need to improve its infrastructure should remain strong.

Goldman, however, warns of a risk of "a slowdown in Chinese metals' use, owing to physical infrastructure constraints." The firm cites "regional shortages in needed inputs or the inability to supply the power necessary for manufacturing activities."

No market is an island, and gold, more than any other commodity, has been carried higher by a broader shift in economic fundamentals, and particularly by the dollar's descent. With most analysts looking for further dollar weakness, gold may continue its ride. Melek thinks the metal could hit $440 per troy ounce -- about $30 above its recent level -- although he considers that price "unsustainable over the long term."

But O'Neill has a different vision. He sees the dollar stabilizing in 2004, as U.S. economic growth continues and interest rates start rising. Such a turn of events wouldn't help gold, he notes.

And continued demand could lift corn and soybean prices in '04. With a reduced 2002-03 corn crop, China isn't likely to be jostling with the U.S. in world export markets, as in the past two years. In fact, "China doubled its soybean imports this year" from the U.S., says Alaron grains analyst Tim Hannagan. Its hefty demand is "going to go on in 2005, 2006, and probably beyond." So soybeans could reach $8.65 a bushel by spring, he predicts.

Commodities are likely to benefit from the new fashion for investment diversification, which is being followed by many private investors and institutions alike. Deutsche Bank's global chief investment officer for private clients, Klaus Martini, is recommending a 10% portfolio allocation to such alternative investments.