Saturday, June 03, 2006

Garnaut is wrong: Supply effects will weaken the commodity price boom

Economics shows that large and unexpected increases in demand will strongly increase prices for commodities in inelastic demand. However sustained price increases will induce firms to employ more inputs to produce more so that, longer-term, prices will be moderated by increased production.

With respect to commodities, such as mineral products and fossil fuels, supply can be increased by increasing production from existing mine sites and by exploring for new ones.

Recent evidence from Geoscience Australia shows that exploration efforts in Australia are experiencing explosive growth in the face of the current commodity price boom. Over 2004/2005 mineral exploration spending in Australia rose 31% to a bit more than $1 billion. Of this 39% was spent exploring for new deposits.

Around the world spending rose 38% to US$5 billion. 59% of mineral exploration effort occurred in Western Australia - though it rose in all states except Victoria.

Much of the expenditure is for gold ($391 million) but significasnt amounts were spent on base metals exploration and iron ore.

The efforts have resulted in significant new resource discoveries. As the Treasurer Peter Costello has pointed out such successes will take the edge off the commodities price boom and sink the short-sighted views of Ross Garnaut and others who suggests that because of the new 'China factor' this boom will last for decades. It won't. Moreover the boom will end even if Stephen Roach and others are wrong in identifying current commodity price trends as a bubble which will be eventually pricked by moderating commodity demands in China.


Andrew Leigh said...

Your post made me think again how odd it is that we don't spend more time scoring the accuracy of our pundits' predictions.

Oh, and I don't think Ross has an L in his last name.

hc said...

Corrected thanks.

Patrick said...

$391 million on gold??

Well, there's a few companies whose shares might not be the best long-term buys.

hc said...

Currently Patrick its a pass-the-parcel game at the speculative end of the market. The heavyweights (BHP-Billiton, Rio Tinto) look cheap on fundamentals but they are not because investors understand this is a cycle which will end.

Your point valid for these speculative stocks. As Trevor Sykes pointed out 35 years ago the main thing many of these companies are minining is people's pockets.