1. Commodity Price Outlook How long can the high prices be sustained?
Hello ladies and gentlemen, my name is Paul Gray and I am a Commodities Analyst with Goldman Sachs JBWere (the Australian arm of Goldman Sachs).
I would like to thank Paulo Bahia-Guimaraes and IBRAM for inviting me here today to make this presentation.
Over the next 30 minutes or so I would like to discuss the commodity outlook as we see it at Goldman Sachs JBWere.
I will start by making some generic remarks about the macro drivers of demand and supply for industrial metals and minerals; this will be followed by some specific remarks on four selected commodities of growing importance in world markets and Brazil in particular. These are:
- Iron Ore
- Aluminium/alumina
- Copper
- Nickel.
At the end there should be time for some questions and answers. So thank you kindly for your attention.
Goldman Sachs JBWere Commodities Team Melbourne Malcolm Southwood London Paul Gray

2. Commodity Price Trends: the start of a new era, or top of the (super) cycle?
So, let’s go!
Now, let me say at the outset that Goldman Sachs JBWere is a firm proponent of the “stronger for longer” outlook for commodities.
Notwithstanding the current US induced credit squeeze and associated housing slump, we believe the forces that have driven commodities higher in the past couple of years remain largely in place today.
The most important being the underlying fundamental driver of demand - China’s voracious appetite for raw materials (spanning from agricultural commodities to iron ore).
China’s transformation shows absolutely no sign of fading – and even when it eventually does (which could be decades away) India will be waiting in the wings to pick up the slack!
So the answer to the title on this slide – this is not a bubble that’s about to burst, we are most definitely at the start of a new era!

3. This slide summarises our views and we believe it paints a pretty compelling case for investment in the natural resources sector.
The bullish long-run demand outlook, coupled with supply-side constraints, suggests that, on average, commodity prices will remain high relative to historical levels. The key point to note here is that the secular decline in real commodity prices has ended.
If you think about it, that’s a remarkably bold statement!
The laws of supply and demand have always worked well in the resource markets. High prices discourage demand via substitution and innovation, and encourage producers to create more supply. That is why real commodity prices have tended to fall.
So what has been different in the current cycle?
- Is the China growth miracle leading to a bigger demand shock than seen in the past?
- Is supply facing serious constraints that never occurred in the past?
- Or are financial flows the driving force behind higher prices?
We will attempt to address all of these questions today!

4. The World and the BRICs dream
For the next 2 slides we have drawn on the influential work done by our colleagues at Goldman Sachs on the so-called BRIC economies (Brazil, Russia, India and China).
It’s the fourth BRIC – China – that will occupy most of our discussion this morning, and I make no apologies for the number of times I will use the “C word” this morning! The theme of our discussion is industrial commodities and in this sector in this decade, it really is all about China.
The chart on left shows data for 2005 (and I apologise for that) but we now know that the Chinese economy overtook France and the UK last year and is hot on the heels of Germany! In fact it is highly likely that China will be the world’s third biggest economy in 2007 (after the US and Japan).
As the chart on the right shows, the Chinese economy will be almost twice the size of the US by 2050 and India will be almost the same size as the USA. The much lower populated countries of Brazil and Russia will eventually follow in China and India’s wake.
But that’s 2050 and now its 2007 so I reiterate – for the moment at least – as far as most industrial metals and minerals are concerned, from a demand perspective, it really is all about China.

5. The World and the BRICS dream
The cars on this chart are meant to show roughly when each of the BRIC economies overtakes major industrialised economies. It’s really just a fun way of showing the data in the previous slide.
But the point that I would like to emphasise is that the global economy has been enjoying its best run of growth in over three decades, with annual growth in real GDP averaging around 5% in the past five years.
Not surprisingly, this has created a positive backdrop to commodity demand, especially in emerging Asia, where economic growth has averaged 9% a year over the period.
When we applied the good work done by Goldman Sachs on BRICs to our commodity forecasting models, we concluded that the BRIC’s phenomenon has essentially lifted global trend consumption rates for base metals by approximately 1 % point.
So whereas we had all become accustomed to a global trend demand growth rate of ~2.5% pa for Cu and Al during the 80’s and 90’s, we now need to think in terms of underlying trend growth rates of at least 3.5% pa.

6. China: the dominant force in global commodity markets
I think this slide clearly shows China’s dominant position in a wide range of industrial metals/minerals!
China is currently undergoing the greatest migration from the land to the cities that the world has ever seen. This rapid urbanisation is generating huge new demand for energy, steel, aluminium, copper and a long list of other industrial commodities that are required to build the skyscrapers, houses, factories, power and transportation systems needed to sustain the growth aspirations of 1.3 billion people! Here are a couple of examples:
- China’s urban population is currently estimated at 532m; by 2020 it will have almost doubled to 970m!
- China is currently building coal fired power stations at a rate of 2 every week!
And in 2006 China added electricity generation capacity almost equivalent to France’s entire network (in other words, 1 year’s growth in China is equal to the existing generating base in France!).
We could go on and on with statistics like this but we don’t have time this morning.

7. How long can it last? “saturation point” is typically $15,000 – $20,000 real GDP/capita (PPP adjusted) – China is still < $7,000!
Per capita consumption of steel and copper
Source: IMF World Economic Outlook
So, if we accept that China is a big consumer of raw materials that is growing a rapid pace, next we have to consider how sustainable that growth is.
To assist we have drawn on work done by the IMF, published in their latest World Economic Outlook. The above charts are based on annual data going back to 1960 and it shows that per capita consumption of steel (and copper) rises with income and generally reaches a saturation point between $15-20k real GDP per capita - that’s when an economy typically passes through the most rapid phase of industrialisation and infrastructure building, before becoming more services orientated.
However, demand for metals (and most industrial commodities) can continue to grow beyond this income level if industrial production and construction contribute significantly to growth - Korea being a case in point.
So far China, with a PPP adjusted real income of $6,400/capita has closely tracked the Korean experience.
Notwithstanding the Chinese government’s attempts to rebalance growth from investment to consumption, our best guess is that rapid growth in construction activity and infrastructure needs will sustain China’s consumption growth rates for basic materials significantly above global trend rates for the foreseeable future.

8. The China (and India) growth story has many years to run
Examining this in more detail we calculate that in the past six years, China’s per capita consumption has climbed by around 80% for copper, 150% for aluminium, and 50% for oil. Yet, as shown in this slide, per capita consumption of resources in China and India is still extremely low by the standards of more developed economies, and is certain to rise steadily for the foreseeable future. Given the size of the Chinese and Indian populations, increases in per capita demand imply massive volume growth in demand for commodities.
So the long-run outlook for demand is clearly very bullish given that emerging Asia is still at a relatively early stage of its development. The share of the population living in rural areas is still 60% in China and 70% in India, compared to only 20% in a more developed country like Korea.
The demand for commodities will continue to soar in emerging Asia as the region industrializes and wealth grows.
Importantly, global growth in the years ahead will be driven increasingly by countries where manufacturing accounts for a relatively large share of output, and where there is enormous pent-up demand for commodity-intensive products such as housing, automobiles and appliances. Thus, going forward, it would not be surprising to see some upturn in the ratio of resource consumption to GDP growth.

9. Challenges to supply growth (1)
Quality and availability of projects: location; size; depth; grade etc.
Infrastructure: availability; cost; lead-time.
Personnel: Labour availability; skills shortages.
Capital equipment: extended lead-times.
Capital costs: have risen dramatically.
Financing and decision-making: What is an appropriate long-term price?
Prices, of course, are determined by the interaction between demand and supply, and supply trends have had a dominant influence in the past couple of years.
Commodity producers have had an enormous incentive to boost output in order to capture the rewards from high prices, but the absence of a supply deluge indicates that powerful forces are limiting the growth in output.
For example:
- An extended period of previous underinvestment in developing new production capacity has left a legacy of bottlenecks and shortages.
- Many resource companies have focused more on buying out competitors than on increased exploration and development spending. Industry consolidation has not been conducive to expanding production capacity.
- This is reflected in the fact that major companies accounted for only 30% of metals exploration spending last year, down from 60% in 2001.
- And, increased costs have eaten into exploration and development budgets, reducing the capacity payback for each dollar that is spent.

10. Challenges to Supply Growth (2)
So, there should be little argument that current prices present a huge incentive for commodity producers to boost output. And, indeed, global metals exploration budgets rose by almost 50% last year to a new all-time high, and further increases are expected this year.
However, the crucial issue is timing - existing mines can sometimes expand capacity relatively easily, but finding and developing new resources typically takes years, not months. This chart shows a best possible scenario for developing a typical greenfield mining operation, but in today’s market where supply of all inputs remains seriously constrained, it can often take much longer than the 7-8 years depicted in the chart.
In some respects the situation is becoming even more problematic because the easy discoveries have been made, and much of the potential increase in capacity is in geopolitically unstable areas and/or environmentally sensitive regions.
Finally, the supply response for many industrial metals and minerals continues to be hampered by labour disputes and other disturbances in a number of countries – symptomatic of operating in a high commodity price environment.

11. Challenges to Supply Growth (3):
This is my final slide on the subject of supply side constraints.
I think it’s pretty self explanatory – lead times for most large pieces of kit are approximately double their normal levels.
And if you are a small producer with no previous relationship with suppliers it could take even longer!
So, to summarise on supply, the bottom line is that current supply tightness in resource markets will not last indefinitely, but a return to the easy conditions that led to a long-run decline in real commodity prices is not on the horizon.
Supply will need to rise steadily just to keep pace with the higher trend growth rates in demand, and relatively high prices may be required to keep the market in balance.

12. Iron Ore
Seeing as CVRD is the world’s biggest supplier of iron ore to the seaborne market this seems like a logical commodity to start with!

13. Iron Ore: Seaborne trade - it’s all about China!
This first chart illustrates the importance of China in the seaborne iron ore market.
We estimate that China will import ~380mt of iron ore this year, representing almost half of total global trade.
By 2010 we estimate that China’s import requirement will be ~565mt which will represent ~57% of global trade.
And I should say that we regard our forecasts for Chinese pig iron production growth as quite conservative: over the past six years Chinese pig iron production has grown at an average rate of 22% pa, this year we are forecasting 17% growth, falling to 12% in 2008 and stabilising at 8% pa thereafter.
So if history is any guide to the future there is clearly upside risk to our projections for China’s iron ore import requirements.

14. Iron Ore: Chinese Imports.
This chart shows monthly Chinese imports of iron ore.
The two points to note are:
the rapid growth that has occurred since 2004
and the big swings that occur in monthly imports.
The latter is due to a variety of reasons, notably stock-building or de-stocking in anticipation of changes to contract prices (for example at the moment the Chinese are thought to be building stocks ahead of next year’s contract price rises and also in response to domestic mine closures/disruptions due to flooding); we also typically see a pick up in imports during the autumn months ahead of the winter when many of the iron ore mines in the north of China freeze up.
But aside of these monthly variations I think it’s clear to see the strong underlying positive trend in Chinese imports of iron ore.

15. Iron Ore: where are the Chinese imports coming from?
As you can see from this chart, Australia is the main foreign supplier of iron ore to China. But Australia’s share has declined over the period shown to ~38% so far this year, while Brazil and India have gained share in Chinese market.
However, market share data needs to be viewed in context, because over the past few years the seaborne market has been “supply constrained” and all shippers have in fact been running at maximum capacity.
So market share has been more a function of availability rather than price, quality or marketing expertise! This explains India’s emergence as a major supplier of iron ore to China despite the quality/reliability and scale problems associated with Indian iron ore exports.
So the incumbents are currently struggling to satisfy their customers requirements. But this will change. As you’d expect, after four years of rapidly rising prices, the supply side is responding and we expect supply and demand in the seaborne market to be more closely aligned from 2009.
If and when iron ore does eventually switch back to a buyers market, Australian suppliers should be particularly well positioned relative to their Brazilian counterparts for sales to China, due to the significantly lower landed cost of Australian ore into the Chinese market.

16. Iron Ore: Beware the Chinese supply response
Iron Ore: Beware the Chinese supply response! Domestic mine production rises to fill gap created by shortage of imports but Av. Fe grade is declining.
Having endured 5 consecutive years of rising iron ore prices, as the world’s biggest buyers, the natural reaction for the Chinese has been to expand their own domestic iron ore production as an alternative to importing expensive foreign ore.
As the chart shows, China has done a pretty good job here: run-of-mine production of iron ore has increased at an average rate of 30% pa for the past 3 years and is on track to rise by at least 20% this year.
However, China is not well endowed with good quality iron reserves - average head grades are declining and conditions are difficult in some mines. Many are small scale, using old equipment and rely on supplying local steel mills.
In short, they are resource inefficient and environmentally damaging.
Expanding domestic production of low-grade iron ore may bridge the gap in the market created by a shortage of supply from the incumbents but it is not the solution to China’s long term iron ore requirements.
Investment in foreign iron ore assets is a more probable route and Beijing is actively encouraging steel mills to create strategic partnerships with iron ore suppliers in Australia, Brazil and Africa. As this occurs and as China’s steel industry consolidates we believe her import dependency (shown by the blue line) will steadily increase.

17. Iron ore: Capesize freight rates – remain high and volatile.
It’s important to say a few words about freight because the seaborne freight component of the landed cost of a tonne of ore into China can be as high as 60% for Brazilian ore and ~35% for Australian!
On this chart we have plotted two major cape-size iron ore freight routes on a spot basis (Brazil/China and Australia/China). The two markets tend to move in unison but during periods of extreme tightness in the seaborne iron ore market, such as now, we find that the freight differential (the gap between the two lines) tends to blow out.
This analysis is obviously less relevant to the big Japanese or European buyers (who tend to have long term forward freight cover) but it is highly significant for the majority of Chinese buyers who remain highly exposed to the spot freight market. We estimate that less than a third % of China’s entire iron ore imports are secured under long term freight agreements.
So the most effective way for the Chinese buyers to lower their delivered cost of iron ore is probably to become more sophisticated in their use of the freight market by securing long term contracts of affreightment. It’s still early days, but the big Chinese steel groups, led by BaoSteel are certainly making some headway here.

18. Iron ore: Spot prices at record levels
So, what about pricing?
As India has grown in importance as an exporter of iron ore, the Chinese spot price has become a more reliable marker and leading indicator of contract prices.
We have done work that shows a correlation between the average spot premium (for Brazil and Australia) in the six months leading up to a contract settlement and the actual outcome of the annual negotiations.
If that relationship holds true this year then a contract price increase of at least 30% is highly plausible. And if the spot price trend shown in this chart continues for another few months, the contract price rise could in fact be much more than the +30% we are forecasting!
The rise in spot prices that has occurred in recent months is quite phenomenal and symptomatic of a market that is absolutely stretched to the limit. FOB prices for 63.5% Fe Indian fines were recently quoted at $115/t; if you then add on a freight cost of ~$40/t (from India to China) then Chinese importers are paying spot prices of ~$155/t C&F for Indian material. That’s ~$30/t over the delivered price of Brazilian contract ore (assuming spot freight) and clearly puts the BIG 3 in a strong negotiating as annual contract talks get underway over the next few months.

19. Iron Ore Price Cycle
Finally on iron ore; these two charts summarise our price forecasts. We believe contract prices will rise by 30% next year, peaking at this level for two years before declining from 2010 as supply and demand in the seaborne market returns to balance.
However, all we can say with certainty is that the imbalance of supply and Chinese demand will remain the key factor in global iron ore pricing. And this will continue for so long as Chinese steelmaking capacity is boosted by the desire of provincial governments to expand local industry, create employment and tax revenue, with global demand fuelling exports of Chinese steel products.
We do expect supply to eventually catch up with demand and this could be assisted by China’s desire to invest in foreign iron ore mines. As this occurs supply/demand will become more closely aligned and the high cost iron ore suppliers will get squeezed out of the market.
Finally, structural changes in the Chinese steel industry (consolidation/rationalisation) and relocation towards coastal areas, as well as product quality considerations and the emergence of more sophisticated freight risk management should all lead to a growing preference for large scale deliveries of high grade foreign ore. Good news for the world’s low cost efficient suppliers of iron ore.

20. Alumina & Aluminium

21. Aluminium: Short-term Caution; Medium Term Optimism
We are bullish on the longer term prospects for aluminium.
We believe that the world is only just beginning to learn that the cost of energy (in most forms) is rising. This will exert “cost-push” on the aluminium industry cost curve.
We estimate that an appropriate long-term price for aluminium is US$1.06/lb (~$2,340/t) in 2012 nominal terms.
Aluminium should become an increasingly attractive business for companies able to secure:
Genuinely long-life, low-cost power tariffs.
Power from “green” sources.
Access to quality bauxite and ownership of low-cost alumina capacity.
But in the medium term, we see overcapacity in China, fed by the current surge in alumina production, as a drag on metal price prospects.
Our annual average 2008 price forecast for aluminium is 95c/lb ($2100/t) which is probably a little below the consensus view.

22. Aluminium: China’s Aluminium Industry Policy
As with so many commodities China has had a dramatic impact on the global aluminium market in recent years and will continue to do so for many years to come.
In the first seven months of 2007, China’s primary aluminium production rose 36% vs pcp.
This was achieved through a combination of capacity increase, and sharply higher utilisation of existing capacity.
Meanwhile, China’s apparent consumption of primary aluminium is running 40% above pcp and we estimate that real consumption is up by ~30% this year.
But, changes are afoot - Beijing is increasingly discouraging growth in smelter capacity:
Enforced closure of smaller, older, dirtier, and inefficient smelters.
Tougher on project approvals.
Removal of preferential power tariffs for many smelters.
Effective abolition of alumina tolling agreements.
Abolition of VAT rebates, and introduction of export taxes.
Abolition of 5% import duty on aluminium from 1 August 2007.

23. Aluminium: Bauxite imports - mainly from Indonesia
How has China managed to grow its aluminium industry so rapidly? Well, its been largely fuelled by imported bauxite which, as this chart shows, has partly displaced imported alumina.
Incidentally, over 90% of China’s bauxite imports in 2005/06 were sourced from Indonesia:
What are the barriers to growth for China’s aluminium/alumina sector?
Access to Domestic Bauxite: Longer term, we believe that the size, quality and dispersion of China’s bauxite resources will inhibit the development and sustainability of China’s alumina industry. However, we do not believe that this will become an issue until beyond 2010.
Access to Imported Bauxite: We question the sustainability of Indonesia as a longer-term source of imported bauxite. Australia (and possibly India) may become important alternative sources.
Environmental: Many of the new refinery projects are operating without central government approval. Red mud disposal is already being cited as a major problem which we believe is likely to attract aggressive government intervention.

24. Chinese smelters dominate the top end of the cost curve
This slide is intended to illustrate the fact that due to their relatively insecure alumina supply position and relatively high cost power, Chinese smelters generally dominate the high end of the cost curve.
Which makes it kind of surprising why they have expanded production so aggressively in recent years and kind of believable that government policies aimed at cooling investment in this sector should ultimately prove successful.

25. Aluminium: longer term, we see China as a net importer
We believe capacity additions to Chinese aluminium smelting will become less attractive as time goes on, for the following reasons:
Chinese smelters are already concentrated at the high end of the cost curve.
Power costs will continue to rise.
Government policy will lead to further erosion of export incentives and tariff protection.
Limited bauxite availability may force continued high dependence on alumina imports.
We therefore expect:
Smelter capacity additions will slow, with domestic demand overtaking production by 2009.
China will become a net importer of aluminium.

26. GSJBW Aluminium Price Outlook to 2011
So, just to conclude with aluminium:
Our price forecasts (expressed in US c/lb) are shown on this chart together with our projected stocks:consumption ratio.
In the medium term we believe the aluminium market fundamentals are less compelling than some of the other base metals, primarily due to the rapid growth in supply that has occurred, notably in China.
However, longer term the fundamentals look quite supportive - in a high energy cost environment aluminium smelters will become increasingly reliant on stranded power and many relatively high cost plants will fall by the wayside.
As China switches from exporter to importer around the end of the decade the global market should move back into deficit and prices should rise accordingly.

27. Copper

28. Copper: historical price series
Bullish copper is one of the strongest calls among all the commodities that we analyse.
The critical difference between copper and the other major base metals is that we struggle to identify sufficient new capacity being developed quickly enough to move the market to sustainable surplus.
We acknowledge that relative to consensus our views are:
Probably a little more up-beat about China’s demand for copper over the next four years.
Probably a little more down-beat about the ease of developing greenfield mine projects.
The result is that we model a market in which demand has to be destroyed in order to achieve balance.
This implies that metal will be priced according to what the marginal consumer must pay to stay in business, and not according to the marginal cost of production.

29. Copper: the need for new supply
This chart is fairly self explanatory – under investment in exploration has had a profound impact on global copper reserves and grades.
Also, the average size of greenfield project is much smaller than the existing major mines. For example – the major copper greenfield projects such as Oyu Tolgoi and La Granja will be ~300 ktpy which is big but nowhere near as gig as some of the incumbents like Escondida (~1.5mtpy, Grasberg ~750ktpy).

30. Copper: Assessing the impact of a slowdown in the US housing market
Not surprisingly, this is one of the most frequently asked questions we have had on the copper market in recent weeks. We recently lowered our copper demand growth forecast for the USA to -1% in But fluctuations in US copper demand have far less impact on the global supply/demand balance than in previous cycles. As we highlighted earlier, China is the main driver – it consumed twice as much copper as the USA in 2006 and is still growing at double digit rates.
Nevertheless, we have made some calculations on the impact of a US slowdown: we believe that residential construction accounts for ~one-sixth of US copper consumption and if we assume a 25% fall in US housing starts this year it would equate to ~100,000t of “lost” copper demand. Obviously fewer houses means fewer domestic appliances – based on CDA estimates of copper contained in domestic appliances a further ~5,000t of copper could be “lost” to this sector.
However, while the US housing market is clearly suffering, non-residential construction spending is actually running ~15% above last years rate and this should boost copper consumption by ~50kt according to our calculations.
So the net loss to the copper market due to changes in the US construction sector could be in the order of 50,000t or 2.5% of US copper consumption and only ~0.25% of global copper consumption!

31. Copper: Costs and Margins
When analysing commodity markets it’s quite instructive to examine prices in relation to costs – and that’s precisely what these charts do.
Our most recent (2006) copper cost curve pegs the median cash operating cost at 70.7c/lb, and the ninth decile at 124c/lb.
That means that with an average LME cash price of 305c/lb in 2006, the median copper mine enjoyed a record theoretical cash margin of 234c/lb or 77% of the LME price.
The fact that the copper price has moved so far ahead of the marginal cost of supply in 2005 and 2006 is, we believe, indicative of a commodity market in severe deficit, such that the metal is being priced by what the marginal consumer is obliged to pay to remain in business.
Throughout the 1990s, the median cost of production trended lower in nominal terms, helped largely by a strengthening US dollar. This trend has subsequently reversed. Between 2001 and 2006, the median cash cost rose by 59%, and the ninth decile by 65%.

32. We Expect Six Years with the Average Copper Price above US$3.00/lb!
So – just to summarize on copper;
The market is currently in deficit and in our opinion is unlikely to return to surplus within the next five years.
We think demand will remain strong regardless of the US housing slowdown and supply will struggle to meet market requirements due to the complex nature of developing new copper deposits.
We therefore remain comfortable with our above consensus call for copper prices to average ~$3.40/lb (~$7,500/t) for the next four years.

33. Nickel
Now on to the last commodity that we will look at in detail before making some concluding remarks..

34. Historical Nickel Price Series
This is a quite a spectacular chart!
Nickel above $20/lb really was bubble territory but $12/lb is still an extraordinarily and, we believe, unsustainably high price for nickel.
In contrast with copper the nickel market fundamentals are deteriorating:
Stainless producers seeking to minimise nickel use through higher proportion of 200 and 400 series alloys.
Rapid growth in low-grade ferronickel output in China.
Two major greenfield projects due to start-up in 2008.
We believe that these circumstances will encourage:
Producers and speculators to sell forward.
Consumers to delay purchases.
We forecast a modest surplus in 2007, and widening surpluses from 2008 through 2011.
In a nutshell, we expect prices to fall further.

35. Nickel: China is Driving Short-term Supply Growth
Record high nickel prices – and the inability of the global mining industry to satisfy China’s insatiable appetite for nickel for use in stainless steel – have spurred a boom in nickel processing by small scale Chinese producers.
They employ a processing route that is highly labour and energy intensive and environmentally challenging. They use low grade ores that (in normal circumstances) would be regarded as waste rather than raw material feed. The end product is a nickel bearing pig iron, typically high in contaminants such as phosphorous which is generally only suitable for the manufacture of lower value 200 series stainless steels.
This year we estimate that China will produce ~90kt of Ni from this innovative form of processing.
The original source of feed was low grade nickel ore from the Philippines (~1.2% Ni) but as the chart shows, China has recently been taking a lot more feed from Indonesia and more recently New Caledonia – the latter having a nickel grade of more like 2%.

36. Nickel: Chinese ferronickel production outlook
Despite the obvious inefficiencies of the Chinese nickel pig iron production. It’s probably here to stay for the foreseeable future, albeit in lower volumes than is currently being produced.
We estimate that the breakeven price for the low grade Pilipino ore is ~9/lb or ($20,000/t) and for the New Caledonian ore it could be as low as $6/lb ($13,200/t).
We believe that our base case assumption for Chinese ferronickel production is conservative:
Implicitly, we assume no growth in output from 1H2007.
We assume price sensitivity will curtail and reduce output from 2008.
But on the other hand we recognise the potential for further cost reduction through:
Use of higher ore grades
Building dedicated furnace capacity adjacent to ore sources.
Improving recovery rates; reducing coking rates.

37. Nickel: Costs and Margins
As with copper, it is also instructive to examine nickel prices in relation to costs and margins.
Our most recent (2006) nickel cost curve pegs the median cash operating cost at 329c/lb, and the ninth decile at 622c/lb (Chart 5).
With an average LME cash price of 1101c/lb in 2006, the median nickel producer enjoyed a record theoretical cash margin of 771c/lb or 70% of the LME price. Year-to-date, the nickel price has averaged above 1800c/lb in 2007, implying further significant expansion of the median cash margin this year.
As with copper, we believe that the wide median cash margin reflects a metal in global deficit being priced by the need for demand destruction.
The steep upwards trend in the median cash margin through the past 16 years, albeit with a superimposed cyclicality, is quite different from the flatter margin trends for the other base metals.
Interestingly, the median cash cost for nickel production rose by 96% between 2001 and 2006, while the ninth decile rose by 179%, representing both a very significant step-up, and steepening, of the cost curve; far more than for any other metal.

38. Nickel: we expect prices to continue falling
So, as with copper and aluminium, this chart summarises our view on the nickel price and stocks:consumption ratio.
As we noted earlier, the sustainability or durability of Chinese nickel pig iron production is one of the big swing factors or unknowns in the nickel market.
Our base case assumption implies that as new supply is commissioned from lower cost conventional methods it will gradually squeeze out this high cost environmentally challenging source of supply, although we do acknowledge the possibility of significant cost and efficiency gains if smelters are eventually built close to the source of feed (eg New Cal) and this is clearly under consideration by some companies.
Nevertheless, as the chart shows, our base case assumption is for nickel prices to peak this year and fall quite sharply over the next four years, gravitating towards a long term price ~$6/lb.

39. Summary/Conclusions
A powerful combination of BRIC’s related demand growth and supply side constraints means that commodity prices will remain high relative to historical levels.
The secular decline in real commodity prices has ended.
We prefer commodities for which we see a weak or delayed supply response.
We prefer commodities that China cannot provide for itself.
We prefer upstream (mining) to downstream (smelting/refining/fabricating).
China can build smelters, but cannot create ore bodies!
Resource company share prices have not displayed the same frothiness as the underlying commodities and many still offer good long-run investment potential.
The bullish long-run demand outlook, coupled with supply-side constraints, suggests that, on average, commodity prices will remain high relative to historical levels. The key point to note here is that the secular decline in real commodity prices has ended.
The real uncertainty relates to the timing of a stronger supply response to current high prices.
In today’s presentation we deliberately highlighted one base metal (Ni) where supply has already responded to super-normal prices and profits. But there are still a number of forces, such as geological or infrastructure constraints, industry consolidation and rising costs, that suggest the inevitable step-up in supply will be a gradual process for many other commodities – and we would certainly put copper in that category.
On that basis, prices seem likely to stay high by historical standards, ensuring that companies in the resource area continue to earn high returns.
Thus, it is important to distinguish between investment opportunities in the underlying commodities and in commodity-related equities. The shares have not displayed the same frothiness as the commodities themselves, and still offer good long-run investment potential.
For anyone considering investing in the Australian Resources sector of the equities market Goldman Sachs JBWere would be delighted to assist you in your investment decisions!

40. Muito obrigado e boa sorte! Paul Gray
It has been my pleasure to make this presentation today and I thank you kindly for your attention.