Metal prices on the rise again

What do the following businesses have in common?

Anglo American Antofagasta BHP Billiton Eurasian Natural Resources Fresnillo Kazakhmys Lonmin Randgold Rio Tinto Vedanta Xstrata

The answer is that they are all multi-national mining businesses that have a listing on the UK stock market. To have eleven mining companies listed in the FTSE-100 index of leading shares is an indication of the growing importance of commodities in the world economy. Metal prices are on the rise again as economic growth rebounds in the global economy and prices are driven higher by supply-side shortages in the market. The continued rapid growth of the BRIC economies (notably China) is the dominant demand-side influence on the market as this article from BBC news makes clear.

One of the key recent developments has been the increasing importance of commodities as an asset/investment class in its own right. Indeed in 2009, commodities were the best performing major asset class behind equities. There has been a dramatic shift in the relative price of commodities since 2002.

After decades in which the real price of many commodities declined (hurting the terms of trade of countries heavily dependent on exports of core commodities) in the last eight years real prices for food, energy and metals have following an upward trend. The main force on higher prices has been growing demand for metals especially from emerging market (EM) countries. EM economies are more resource intensive than richer developed countries. Allied to this, heavy investment in infrastructure building, increases in per capita incomes (driving demand for consumer durables) and the resources needed to allow urbanization have given a huge boost to the total demand for metals.

On the supply side, production of metals in the short run is limited by the long time lags between discovery of new metal supplies and the start of production - lags in excess of seven years are not uncommon. Supply is constrained by the need to win licences for drilling and extraction, bottlenecks in the supply of capital equipment, shortages of power and skilled labour, the heavy financial costs of funding investment in new facilities and frequent geological problems in reaching recently discovered reserves.

Higher global metal prices have a supply-side effect on the UK economy. We import the vast bulk of the metals used in manufacturing and construction, so a new period of rising prices will create new cost-push inflationary pressures and hit the profit margins of businesses that use metals as a vital component of production.

In the short term though, surging global metal prices have the effect of boosting the FTSE-100 index since those 11 mining companies are heavily weighted in the FTSE-100 calculation.