http://torontosun.com/Money/2006/10/15/2032331-sun.html Sun, October 15, 2006 Signs of the times U.S. housing, China's economy are key signals By FRANCOIS POULIOT A worker cleans the sidewalk in front of a giant dollar sign on a billboard for a luxury apartment complex in China, where the economy is still going gangbusters. (AP File Photo) Warning: Are the housing boom and the Chinese boom on the verge of going bust? That's the question on everyone's mind these days on the metal market, while the mining sub-indexes of the major derivatives exchange are under pressure. We thought that the sector was in good shape, but the latest statistics released from the United States and China have cast a doubt. The U.S. housing boom and China's phenomenal development are two driving forces that led to the fantastic spike in prices of raw materials and the industry's stocks. Since 2002, the price of aluminum has doubled and the prices of copper, nickel and zinc have quadrupled. On the stock market, Toronto's mine and metal subindex has soared almost threefold. In September, however, it has declined by over 12% (though it recently rebounded). TOO MUCH FOR DEMAND <A HREF="http://ads5.canoe.ca/event.ng/Type=click%26FlightID=35449%26AdID=62607%26TargetID=2580%26Segments=2371,4176,5882,5991,6019,6026,6038,6137,7542,9314%26Targets=439,6268,4362,4776,2942,2580,6569,4870,6380%26Values=25,30,50,60,72,80,92,101,110,155,213,255,298,332,342,343,344,345,346,379,380,395,493,860,1281,1304,1315,1445,1467,1544,1551,1567,1570,1620,2292,2307,2402,2408,2540,2553,2570,2572,2640,2701,2703,2788,3069,3080,3453,3562,3621,3719,3720,3797,3832,4347,4778,4802%26RawValues=%26Redirect=http://www.jobboom.com" target="_top"><IMG SRC="http://imageads.canoe.ca/Domestique06/Canoe/Campagne%20nationale%202006/Anglais/Jobboom%20EN/cn_en_jobboom_20060925_300x300.gif" WIDTH=300 HEIGHT=300 BORDER=0></A> So where are we heading now? In August, the number of construction starts dropped by 6%. When we compare the number of housing starts with the buyers' interest (the index of traffic of prospective buyers), we get an incredible difference. There's too much construction for the demand. National Bank Financial estimates that even a decline of 20% in housing starts wouldn't bring back the ratio to its historical average. In a recent note, Morgan Stanley also sounds the alarm. On a year-over-year basis, family housing unit starts should drop by 25%-30% in the second half of 2006. For now, we can pin our hopes on industrial and commercial construction, which still manages to counterbalance the difficulties of the residential market. But it's hard to imagine that the slack in homes won't eventually affect it indirectly since GDP will fall. Could the drop in the residential market pull the economy towards a recession? It was the catalyst sector that propelled our last recovery, and seeing it slump could affect how consumers and the corporate executives react with their investments. We wouldn't bet too much on a recession in the short term (one year). Indeed, it wouldn't be surprising to see the U.S. Federal Reserve intervene again with a rate reduction to boost the demand. We must, however, note that this cure, used at too close intervals, has limits. The moment will come when we will have brought down personal savings too low while adding too much to the housing stock. Bottom line: The American economy shouldn't fall into recession shortly. But we seem to be getting closer. Now let's examine the Chinese situation, which is quite complex. Because the rampant demand that it generates brings significant inflationary problems (it strongly increases prices for raw materials), China has started to take measures to reduce its rate of economic growth. The menu features borrowing rates in rates and i bylaws intended to slow down the expansion. Although we must be careful when using one single monthly piece of information, results are coming to light. Investments in real estate assets increased by 21.5% year-over-year in August, compared to 27.4% in July. SPECULATION IN METALS Some speculate that a more pronounced decline is to come. Maybe, but unlike the U.S., we're still talking growth, big time. China still needs significant investments in infrastructure, particularly before the 2008 Olympic Games. Conclusion? Demand for metals should still hold for a while in the United States and should continue to increase in China. Apparently there's no need for a mining investor to start screaming ,"Take cover!" But there is a third problem for the metal industry: Speculators. In recent months a lot of people have started to purchase metals such as copper, nickel and zinc. Prices appear to be in complete desynchronization with the level of inventories of the last few years. For instance, in 2005, a pound of nickel was worth $8 US. Today, with inventories at a higher level, it's traded at approximately $14. That's stratospheric. One day speculators will cash out. It would probably be wiser to beat them to it.