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It gave the world COVID-19 and now it looks like China is giving the world inflation, and while some people might not see the connection between COVID-19 and inflation, they are both a threat and an opportunity for investors.

To understand the significance of an inflationary outbreak, you only have to look back 18 months to see how a disease can turn financial markets upside down. Heavy losses at the start and fat profits later.

AUTHOR: Tim Treadgold (Resources Rising Stars)

Inflation, if allowed to rise too far, is an equally dangerous infection which destroys the value of certain types of investment (especially cash), but the flipside is that it improves the performance of hard physical assets such as property, gold and other commodities.

A headline on a website yesterday, probably written by someone under 40, highlights the lack of understanding about inflation. It read “Base metals rise despite Chinese inflation”.

The truth was that base metals rose “because of inflation”, as did the rest of the commodity complex with investors and commodity consumers buying now to avoid higher prices later, which is what inflation is all about.

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The next few months should see an increased understanding of the inflationary threat but to see how it might spread take a look at China, where factory prices as measured by the producer price index are up 9% on 12-months earlier, the biggest rise since 2008.

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Those higher prices in China are being driven by the commodity boom which China started with its economic stimulus and being fuelled today by the U.S. with its big spending budget which will send a wave of higher prices washing over every country because China, which was once the centre of deflation with its cheap factory labour, is now the centre of inflation.

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To put a few numbers on inflation, consider a 50% increase in the price of copper which is currently selling for $US10,000 a tonne but which Ivan Glasenberg reckons needs to rise to $US15,000/t to encourage investment in new mines, a point echoed by Jefferies, an investment bank.

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As the founder of mining and commodity trading giant Glencore, Glasenberg knows exactly what he is talking about and while copper at $15,000/t might alarm some people, it will drive copper company share prices sharply higher with Sandfire’s 18c rise this week to $7.22 an example – as is OZ Mineral’s 35% rise since the start of the year.

Inflation, which is coming whether you’re ready or not, will be one of the major investment themes of the next few years because of the way it will initially drive commodity prices higher at the start and eventually cause central banks to raise interest rates to combat rising prices.

The other big theme of the next few years is the one that’s been hiding in plain sight for the past three years, the electrification of transport and anything else that can be powered by batteries.

This week saw a flood of positive reports on battery metals, especially lithium, with Macquarie Bank telling clients that “a major recovery in electric vehicle sales is leading to a huge increase in demand for battery metals”.

Macquarie said global EV sales in the first four months of the year were up 151% from the depressed sales of the same period of 2020, a point picked up by Bloomberg New Energy Fund in its EV Outlook report, which expects EV sales to rise from 4% of the market last year to 70% by 2040.

Locally, the EV theme continued to underpin lithium-exposed stocks. with Pilbara Minerals adding 8c to trade at a six-month high of $1.38. Liontown also traded up towards an all-time high of 61c, while Galaxy and Orocobre slipped 13c and 12c lower respectively.

Other banks chimed in during the week with their views on lithium, all positive verging on the excited, as Credit Suisse demonstrated with its opening words that: “the lithium market has turned, fasten your seat belts for EV acceleration”.

Like Glasenberg’s remarkable forecast of a 50% increase in the copper price to encourage new mines, Credit Suisse reckons supply of lithium “needs to grow by 50% from 2025 from new projects which are not yet approved”.

A modest lithium supply shortfall this year of 16,700 tonnes will rise to a shortfall of 58,000t next year and then explode to a shortfall of 248,000t in 2025, taking prices for lithium, whether traded as spodumene, carbonate or hydroxide, with it.

J.P. Morgan reckons spodumene prices, the stuff produced by companies such as Pilbara and Galaxy, will rise by between 10% and 25% over the next five years.

The rush into commodities as inflationary fears rise could be seen in the latest report by Citi, another investment bank, which said that global commodity assets under management rose to a new record in May, up 3.4% to $US723 billion.

“Across the commodity sectors, precious metals had the largest monthly gain in May of $US31 billion and the gold price continued to rally,” Citi said.

Much of the strong performance by gold over the past few months (up 12% since late March) can be attributed to the inflation factor, though this week saw the precious metal take a breather, opening and closing at $US1889 an ounce.

What happens next with gold will be seriously interesting because on the one hand there is the positive factor of inflationary fears while on the other hand there is the increasing likelihood of an end to the era of ultra-low interest rates as central banks start to take their foot off stimulus and begin a process of raising rates – taper time (which can also trigger a taper tantrum).

Iron ore, which had appeared poised for a sustained correction, got another lift from Brazil when Vale, that country’s biggest miner of the material, was forced to close temporarily two of its small mines because of concern about the stability of tailings dams.

The Vale effect helped keep the iron ore above $US200 a tonne and even with a price that represents whopping profits most local iron ore stocks failed to move much and those that did went down a few cents in another pointer to an overdue iron ore correction.

ABOUT THE AUTHOR:

Tim Treadgold brings decades of experience to Resources Rising Stars, offering readers sharp and insightful analysis of current events and breaking news.