Although there was earlier speculation that the metals commodities boom was going to sputter to a halt in 2006, it appears that there is another leg up for metals – despite higher energy costs. This is especially the case for aluminum, copper and nickel. Data is showing that global metals consumption is likely to remain on a strong trajectory due to increasing demand from emerging markets.  

In a number of metals, the dramatic increase in demand has meant the elimination of surpluses. Emerging market economies are a big factor in this. According to one study the BRICs (Brazil, Russia, India and China) are on track to equal G7 consumption by 2010. Between 2000 and 2005, base metal consumption from the BRICs expanded 86 percent from 8.2 metric tons 15.2  metric tons. Of the BRICs, China is expected to rival the consumption of the G7 within a decade.

Adding to the overall demand on metals is economic recovery in Germany and Japan. Both of these countries have remained more metals intensive than the United States since the global metal usage peak in 1973.

Another point to consider is that unlike other commodity cycles, there has been an amazing level of producer discipline. Many management teams have bad memories of earlier commodities booms which stimulated over-production that in turn resulted in price plunges. One last factor helping keep upward pressure on metals prices is a high and increasing level of geopolitical tension, including apprehension that Bolivia’s recent nationalization of gas could be extended to the mining sector, something also under discussion in Peru. If nothing else, many emerging market governments are considering how to get more out of the foreign companies busy extracting their country’s natural resources.

For companies like Phelps Dodge, Aloca, Alcan, Falconbridge and Inco, the metals boom has and will continue to improve their bottom lines. Many companies are flush with cash for the first time in years. Phelps Dodge has little debt left and has already enjoyed one round of ratings upgrades, while others are looking around for acquisition candidates (as with Inco buying Falconbridge). We expect to see more consolidation in the metals and mining sector, with the major companies looking over a long menu of smaller mining companies that continued exploration over the last several years despite lean funding. The following table provides a glimpse at the interplay between the metals boom and improving creditworthiness.

DEBT/CAPITALIZATION (%)

	3/31/06	12/31/2005	12/31/2004	12/31/2003
Phelps Dodge	9.63	12.4	26.5	68.4
Inco	26.0	28.0	30.0	34.0
Falconbridge	33.3	36.6	39.0	45.0
Alcoa	32.4	49.2	47.6	60.5
Alcan	38.0	39.8	56.2	47.2

Sources: Companies financials.

This is occurring despite some typical peak characteristics of worker demands for higher wages, costly inputs and low inventory levels. These companies are also benefiting from a substantial flow of investor money into commodities. According to estimates from Barclays Plc., hedge fund investments in commodities (broadly defined) may exceed $120 billion by 2008, from $80 billion at year-end 2005. We expect the positive trend for metals and mining companies to continue. Despite tight spreads, the sector is attractive. The challenge for the companies is how to manage success, not a bad problem, considering the many years when survival was the issue.