LONDON -

While the prospects for the year ahead for precious metals are perhaps easier to assess (although equally likely to be proved wrong) those for base metals are so dependent on the state of the global economy, where recovery or otherwise is so uncertain, that it makes any kind of prediction fraught with problems.

On the face of things, the general economic consensus out there is that 2009 will be an extremely tough year for the global economy. One reads little in the press apart from doom and gloom as the world plunges into recession and perhaps deflation over the next 12 months. Parallels with the Great Depression are noted everywhere. There are few contrarian views around to penetrate the raft of adverse data, although the investment sector is generally looking a little less pessimistic at the year end with markets rising – even so globally stocks have fallen over 40 percent during the year making it one of the worst on record.

Yet for the commodities sector all the adverse forecasting may not be as it seems – or perhaps we are being overly optimistic in suggesting this. There have been huge falls in base metals prices as industrial production has been slumping and demand has fallen away. But have the falls, and the remedies for them, been overcooked? We certainly seem to have seen this in the price fallout for commodity stocks which bottomed in mid-October and have mostly staged pretty strong recoveries, although still remaining hugely lower than they were only a year or so ago. To a large extent this has applied to the stock market in general, but there is perhaps more vulnerability in the overall economy than there is in the commodities sector precisely because the opportunities for reducing production are far higher, and can be accomplished far quicker, in the latter. Commodity prices depend very much on the supply/demand balance and there is little doubt that the supply side for most metals and minerals is being cut back ruthlessly which should help stabilise prices and lead to new growth in the year ahead.

What is recession as far as the global economy is concerned? A period of zero or negative growth. There is little doubt that much of the world is experiencing this at the moment. But even zero growth suggests a continuance of overall commodities demand at the least relatively close to that seen over the past few years, particularly if the huge economic stimulus packages being implemented across the world begin to have a significant effect on commodity usage. Coupled with enormous output cutbacks from mining companies and the metallurgical sector both by design from the mining majors, and by default from those which in retrospect relied too heavily on recent metals and minerals prices to bring new mines to production and now find they have to shut them down as they plunge into receivership, the mining sector could well in concert have over-reacted to the situation.

Taken along with new project and expansion deferments or abandonments, some of which will not now see the light of day again for many years, and the general declines in output from older mining operations as orebodies run out, or higher grade mining opportunities are diminished, we can expect significant production shortfalls in the years ahead. And with the speed of reaction by the mega miners in reducing production, and reports of mine closures across the whole gamut of the industry, these shortfalls are likely to occur sooner rather than later.

So what are we faced with at the moment Copper is very much the bellwether of the base metals sector and the price has slumped to a current $1.30 a pound, a level last seen in 2004. Only six months ago the copper price was around the $4 mark! Metal stocks still seem to be rising although in truth these only represent a fraction of global demand and are perhaps less relevant in the big picture than the market gives them credit.

On the face of things this suggests a pretty dire time ahead for the copper sector and there still has to be the possibility of further short term price falls. But even the current price level will see more cutbacks as the smaller less financially secure miners go out of business and the majors continue to retrench and we have to be awfully close to a supply/demand balance again.

There seems to be little doubt that western economies will continue particularly weak and will offer little support to the price. But the eastern nations – China in particular - with their huge populations now looking to standard of living improvements as a right, are already beginning to ride to the rescue of the world's beleaguered miners with plans to soak up excess inventory. And with the Chinese domestic political necessity to maintain at least some GDP growth taken together with the anticipated Barack Obama economic stimulus in the world's other biggest consumer, the U.S., one suspects things should begin to turn around in the New Year – or at least after the Chinese New Year which is on Jan 31st this year.

What has happened to copper supplies has been even more apparent in other base metals sectors, notably zinc and nickel, where the price fallout has been more severe and global output is being even more severely cut back. With a good proportion of the world's producers operating at or below break even there will likely be more big production cuts still to come.

Even with all the cuts, price growth will be slow to pick up, while some of the measures to stabilise the sector which have already been taken – notably the implementation of strategic stockpile building in China – will also mean any price buildup will be slower than before as material can be released from these stockpiles to counter any rapid price increases.

But overall, as confidence begins to return to the global economy, which hopefully it should start to do within the next few months, then metals prices should improve, but not nearly as fast as they did over the 2004-2007 period.

BASE METALS STOCKS
Despite the decent rises for many base metals miners, developers and explorers seen since the mid-October lows there still have to be some excellent prospects. There are still-profitable base metals miners out there and with the prospect of rising metal prices in the year ahead this could prove a fruitful investment sector. The diversified mining majors almost certainly fell back too far and their basic financial strengths should see them through the crunch period. They should come out the other side stronger than ever given the excellent prospects for improving their property portfolios with opportune acquisitions.

Amongst the juniors and mid-sized companies, the key is access to sufficient financial resources to see them through the continuing period of weak commodity prices which is likely to continue through much of the year, as even if the markets do pick up they are unlikely to move forward substantially. For the developers finance is still virtually unavailable for all but the strongest projects in the most politically safe environments so operators in areas deemed politically unstable, changeable or downright hostile should probably be avoided by all but those prepared to take strong risks in at least part of their investment portfolio, however good the projects appear on paper.

For the less financially secure companies, but which have strong technical prospects, staying afloat or independent will be a major problem. However the good prospects are likely to be swallowed up by larger companies and given the low stock prices the bigger companies may be prepared to pay decent premiums over current stock prices to avoid hostile bid status, so there could well be some decent upside potential in investing in good takeover targets.

So overall the big commodities price fallout should provide good opportunities ahead as the world pulls out of recession, although this may be a slow process. Some of the specialist mining funds may prove a good safe bet as the fund managers and their analysts will hopefully be doing their homework and picking out the plums amongst the huge numbers of mining companies. But beware, there are a number of less financially secure companies which will undoubtedly fail given the current difficulty in securing funds to cover their day to day expenses. Good due diligence by the investor should pave the way for excellent future portfolio growth.