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UBS Study "UBS research focus". Commodities: scarcity of abundance.
The new report "UBS research focus" from Wealth Management Research projects continued strong growth in demand for natural resources, and cautions that supplies of natural resources will remain thinly stretched in the near term. The report projects continued shortfalls in meeting oil demand, and a peak in oil production within the next quarter century. Underinvestment in the search for base metal deposits will also limit any immediate expansion in production. Countering growing concern that the world will one day run out of precious natural resources, however, the report finds little evidence of long-term scarcity. Specifically, although the market price for energy products and base metals has risen sharply during the past few years, prices are lower than in past cyclical peaks after adjusting for inflation. Moreover, UBS forecasts that natural gas production and other fuel substitutes will likely grow in importance to meet an expected increase in overall energy use. The emergence of cost-effective fuel substitutes will enable reduced reliance on crude oil, and reserves of base metals are sufficient to meet long-term demand forecasts, says UBS.
The new report "UBS research focus" released by Wealth Management Research analyzes how continued strong economic growth rates in highly populated emerging market countries will affect the long-term supply and demand balance for scarce natural resources, and discusses the implications that this has for investments in commodities.
In particular, the new report highlights the following trends:
Consumption of natural resources will expand during the next two decades, driven by continued industrialization and growth of domestic demand in emerging market countries.
Supplies of natural resources will continue to face difficulty keeping pace with demand, encouraging substitution and exploration activity.
Projections of near-term supply shortfalls in natural resource markets, combined with the potential for future substitution effects, suggests that active portfolio management strategies are becoming increasingly relevant for investments in commodities.
Changing face of natural resources demand
UBS forecasts that the composition of global per capita income may be about to change substantially, and, along with it, natural resources demand. The research report projects that the per capita income gap between developed and developing countries will continue to shrink over the next several decades, and shows two fundamental trends that will likely unfold in the next several years. First and foremost, the weight of the developed countries in the world economy will diminish even though per capita incomes will likely remain the highest. Second, the income of the average citizen in an emerging market country will likely improve relative to that of an average citizen in developed countries. Although developed countries will remain the largest end-consumers of natural resources, future growth in demand will likely flow from emerging markets, as per capita incomes continue to rise relative to developed countries.
Summary of the supply and demand outlook
According to UBS's projections, the supply and demand framework for energy and base metals will likely evolve in the following fashion:
Given the high infrastructure and investment costs involved in transitioning to substitute fuel sources such as natural gas, UBS assumes that oil consumption will remain strong in the near term and projects that production capacity will likely trail demand due to geopolitical instability in key oil producing regions. This points to continued oil supply and demand imbalances for at least the next five years. Over the long term, UBS believes that the peak in oil production is likely to occur between in the mid- to late-2020s. The expected slowing in oil supply growth and the potential for much faster growth in the supply of natural gas suggests that natural gas will likely eclipse oil production by 2030, if not earlier. Furthermore, substitutes for crude oil will likely emerge with time but require substantial technological innovation, infrastructure development, and the willingness of governments to remove distortionary energy subsidies.
In the short run, the reserve profile for base metals is hindered by issues relating to underinvestment in mining extraction capacity, as well as international trade and legislative restrictions regarding the environmental consequences of mining. Capital expenditures on metals production is increasing, but is unlikely to have a significant impact on supplies for at least the next three to five years, according to UBS projections. Over the long term, there appears to be no issue of depletion in the next 200 years or so for mineral commodities, like ferrous and non-ferrous metals, given the high resource base availability. Nevertheless, supply shortages similar to the current one will emerge from time to time.
Implications for asset allocation
Given our long-term outlook on commodities, particularly the impressive demand forecasts for emerging markets, UBS thinks that investments in natural resources should play a role in most private investors' portfolios and will be able to stabilize portfolio returns. Given the changing influences on commodity prices, UBS recommends that investors consider more active investment strategies in commodities.
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