The world has been bingeing on raw materials, a trend that seems endless. Yet history shows that a hangover is inevitable.
The demand for commodities has been so intense that manhole covers were disappearing, stolen for the metal contained therein. Scrap metal prices reached virtually unprecedented levels.
Demand appeared to be insatiable, in part due to the tremendous boom in China and other developing economies. A faraway boom in Latin America and a surge in our capital spending typified the seemingly endless requirements.
Most things that were extracted out of the ground experienced a dramatic upswing. Not only was exuberant appetite a major element, but the weak U.S. dollar meant that goods priced in that currency climbed as a result.
Market pundits who had been wildly bullish on the stock market suggested a switch from common stocks to taking a position in commodities. Mine owners borrowed huge amounts to finance developments, almost regardless of costs. A leading U.S. bank stated that this time it is different, that this was not a typical commodity cycle. The devaluation of other currencies such as the Chinese yuan furthered this trend.
There were other factors at work. Cost cutting suggested that commodity producers believed they easily could sustain a fall in raw material prices. The decline in oil prices reduced the cost of production and weak manpower numbers helped too. Generally weak input prices added to the downward spiral in production costs.
The number of oil well drilling rigs fell, so producers increased production to compensate for that, further raising oil charges. In addition Chinese demand has peaked, resulting in a slowdown in requests for raw materials. Counting on a good market, some producers bought small operators that were high cost operations. Also, many commodity producers stockpiled inventories that now overhang the market.
Funding advances have not closed down. As banks have cut loans to commodity producers, others are stepping in, so output remains high. It is not surprising then that a downward spiral in commodity prices ensued. Commodity producers counted on an exuberant world economy but this now is a forlorn hope.
This industry now faces daunting headwinds. Its hopes certainly have been misplaced. The hangover from the end of the wild enthusiasm is settling in, so the commodity boom looks to be over.