Australia’s unexpected iron ore mini-boom courtesy of twin dam disasters in Brazil should have woken resource-sector investors to two largely forgotten forces in commodity markets – outages and shortages.

The outage issue is easy to understand with events in Brazil a perfect example, because when a major supplier of any raw material suddenly trims supply, for whatever reason, the shockwaves are felt around the world.

Perhaps most surprisingly with the Brazilian iron ore event was the scale of what happened, and while no-one should downplay the deaths of at least 200 people, the lost production amounts to an estimated 50 million tonnes in an annual seaborne iron ore market of around 1 billion tonnes.

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In other words, it only took the removal of around 5 per cent of production, and most probably a temporary cut at that, to drive the iron ore price up by more than 30 per cent, taking pure play iron ore stocks such as Fortescue Metals (ASX:FMG) up by 50 per cent, and enough to add around $2 billion to the personal fortune of that company’s biggest shareholder, Andrew Forrest.

Because Brazil is likely to make up the iron ore shortfall over the rest of 2019 by ramping up output from other mines, it would be unwise for investors to assume that the recent dam disasters will be a long-term factor in the iron ore price.

But it would also be wise to recognise just how finely balanced the iron ore (and other markets) are, and how old mines have a habit of delivering unpleasant surprises.

If “outage watch” is not a genuine investment theory, just a wild card that can move markets sharply which provides ammunition for speculators, then “shortage watch” is the real thing and one for investors to brush up on.

Cutting it finer

In one sense, shortages are a variation of outages in that raw material once in abundant supply moves into a phase of under-supply — but over a much longer time.

Two numbers demonstrate how shortages are creeping up on the metals sector: 1.3 and 10.9.

The 1.3 is the “copper consumption ratio” or the number of weeks of consumption of copper held in stockpiles and warehouses around the world. It’s not a lot given the widespread use of copper in industries as diverse as construction (plumbing), electronics and transport (especially the new generation of electric cars).

10.9 is the number of weeks of nickel held in stockpiles, and while nickel is mainly used to make stainless steel and that material is very dependent on China demand, it too is becoming a key metal in the batteries used in electric cars and a myriad of appliances.

What makes 1.3 and 10.9 so very (very) interesting from an investment perspective is that three years ago the numbers were 2.5 and 21.9.

In other words, in 2016 the copper stockpile could meet 2.5 weeks of consumption and the nickel stockpile could meet 21.9 weeks of consumption.

Analysed any way you like, it is easy to see that the world has been living (partially at least) off its stockpiles of metal, and as everyone should know it is impossible to live off a stockpile, or accumulated savings, for long.


A number of investment banks have recently expanded their research of the stockpile issue, largely because it has become more difficult to follow in recent years as Chinese stocks, and material held in the warehouses of the Shanghai Commodity Exchange are much harder to “see” than in the past when data from the London Metal Exchange (LME) was taken as gospel.

Citi, for example, reckons that trackable copper inventories on all metal exchanges (including Comex in the US) relative to annual copper consumption is at a 10-year low.

The LME’s copper numbers show a decline in warehoused material from 385,000 tonnes at this time last year to 147,900t today. Comex stocks have declines over the last 60 days from 118,000t to 73,000t.

Nickel stocks on the LME are down from 340,000t at this time last year to 199,000t, while zinc stocks have fallen from 250,000t to 101,000t.

The case of the disappearing stockpiles is almost good enough for a Sherlock Holmes mystery, or would be if the solution wasn’t so easy to see: reasonable demand bumping into sluggish (or negative) supply growth.

What appears to be happening across the metals world is processes started just over decade ago have reached their natural turning point.

Back in the period before the 2008 GFC it was widely believed that the Chinese industrial revolution would not only change the world (which it has) but would lead to a long-term increase in commodity demand. Who remembers the mantras “stronger for longer” or “this time it’s different”?

It was strong for longer than average, and that led to a mine-investment boom, a surge in merger activity and great confidence in the mining world; until the inevitable happened and a supply surge overtook demand and prices fell.

But that snapshot of history is of events that occurred the best part of a decade ago and today the excess in supply has been absorbed. Gluts are giving way to shortages.

Copper, in the words of Morgan Stanley, is a metal whose “stars are aligned”.

“2019 is at a real pinch point for (copper’s) market balance driven by tightening mine supply, which will bring the market into a real deficit of 380,000t on our base case,” Morgan Stanley said.

“We expected a 2.4 per cent fall in global mine supply this year, which means that global demand would need to be flat to keep the copper market in balance. This is below our base case of demand growth of 1.6 per cent.”

In other words, even with China and the US waging a trade war, and Europe on the brink of a post-Brexit recession, copper is moving into a supply shortfall which means digging deeper into stockpiles which, in turn, puts upward pressure on the price.

Nickel is in the same situation with Macquarie Bank noting the shift from surplus to shortfall, with the shortage factor potentially being hit with an outage event because most new supply of nickel is coming from Indonesia, a country with a track record of mine closures.

If the government of Indonesia springs one of its surprise crackdowns on miners who do have an unfortunate record of environmental vandalism, then nickel could deliver one of its spectacular price rises as the effects of a shortage are magnified by an outage.

Whatever happens next, the key point for investors to remember is that significant investment in new mines started to dry up almost 10 years ago and much of what’s happened has been to replace ageing projects.

What BHP (ASX:BHP), Rio Tinto (ASX:RIO) and Fortescue are doing with iron ore is a perfect example, investing an estimated $8 billion in new WA iron ore mines – but without an extra tonne reaching the export market because the new mines will simply replace those which are closing.

Commodity markets might not be booming, but they’re certainly in a much healthier position than a few years ago as the cycle of supply and demand slowly turns.

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