Supply Crunch Looms in Commodities Markets

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A prolonged period of underinvestment by commodity producers is setting the stage for large price increases in raw-materials markets, say bullish investors who focus on the metals and energy industries.

Prices of copper, nickel and aluminum could soar past prior records—more than 40% above current levels—in the coming years, say the portfolio managers. Such a development would likely transform markets marked in recent years by soft prices and tepid investor interest.

Steady SlideInvestment in new mines has fallenconsistently in recent years.Source: Wood MackenzieNote: 2018 data are estimates through third quarter

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Global miners are spending a third of what they did five years ago on new projects. They’re on track to invest roughly $40 billion for the third straight year—down from more than $120 billion five years ago and $80 billion almost a decade ago, according to commodities consultancy Wood Mackenzie.

Worries that U.S.-China tariffs will slow growth and hurt demand for commodities have weighed on prices in recent weeks. Copper is poised for its third slump of at least 15% in the past five years. Zinc, aluminum and nickel are in a bear market.

But some investors still wager the current rate of investment will tighten supply, causing prices of metals like copper and aluminum to spike. Investors and analysts also expect the much-anticipated shift to electric vehicles to exacerbate any supply gaps.

“It’s incredibly bullish and inflationary for metals on a long enough horizon,” said Stephen Gill, managing partner of Pala Investments. He has been building up stakes in mining companies like Nevada Copper Corp. “You have a window of opportunity at these low prices.”

Analysts say the lack of investment in metals echoes what happened in the oil market. A 25% drop in spending on new projects in 2015 and 2016 set the stage for a rally that sent crude prices to near four-year highs this year.

A worker in a maintenance shop of the Oyu Tolgoi copper-gold mine in the Gobi Desert. Miners are spending a third of what they did five years ago on new projects.

A worker in a maintenance shop of the Oyu Tolgoi copper-gold mine in the Gobi Desert. Miners are spending a third of what they did five years ago on new projects. Photo: Taylor Weidman/Bloomberg News

The potential supply crunch developed after a chorus of investors—burned by the commodity slump that lasted through 2016—demanded greater discipline from mining companies. Mining shares have lagged in recent years. The MSCI World Metals and Mining index has fallen 20% in the past five years, compared with a 3% drop in a broader measure.

Glencore PLC, known for its aggressive investment strategy, shrank annual spending on new projects from 2014 through 2016, according to FactSet. Chief executive Ivan Glasenberg, one of the mining industry’s biggest deal mavens, has said rewarding investors is now the best use of the company’s cash.

Long-Term LagShares of mining companies have trailed thebroader market for years.Source: FactSetNote: Data through Friday

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Other large miners such as Rio Tinto PLC and Vale SA have struck a similar tune, pushing capital expenditures to their lowest level in years and spending billions on shareholder returns.

“None of these mining companies have an appetite to increase supply by spending or acquiring someone,” said Arthur Calavritinos, a portfolio manager at Boston-based ANC Capital, who trades copper futures and has held on to investments in Freeport McMoRan Inc. and Teck Resources Ltd.

Mining deals are on track to total about $40 billion for the fourth consecutive year, a fraction of the record $131 billion spent in 2011, according to Dealogic. Meanwhile, stock buybacks from the world’s largest miners are set to more than double for the second straight year, FactSet data show.

Uncertainty over global trade this year has further deterred miners from commissioning new projects. Companies are also dealing with emerging-market governments increasingly seeking a larger share of profits and imposing stricter regulations.

U.S. copper miner Freeport reduced capital expenditures each year from 2014 to 2017. “We’re not going to start investments until we have clarity about the ultimate outcome of all these current uncertainties,” CEO Richard Adkerson said on an October earnings call. Freeport shares are down 36% this year.

Copper miners will need to spend an additional $50 billion in the next decade to balance the market, said Christopher LaFemina, a mining analyst at Jefferies. Such companies currently spend about $10 billion a year. Zinc is also set for a deficit of several hundred thousand tons, according to Mr. LaFemina, who has “buy” ratings on many industrial metals producers.

Trending DownSpending on mining mergers and acquisitionshas also tumbled lately, fueling bets on long-term supply gaps.Source: DealogicNote: 2018 figures based on year-to-date deals

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Historically, metals prices have responded quickly to tight market conditions. Copper more than doubled to $4 a pound in the one year through May 2006. Prices jumped about 50% to $4.50 in the year through February 2011. The metal currently trades at about $2.75.

“Those types of price spikes are in the future,” said Leigh Goehring, managing partner of Goehring & Rozencwajg Associates, which has stuck with its investments in copper miners. “In a world where supply just doesn’t grow, you’re layering on top all this new demand.”

A rising metals market would benefit countries that are big exporters of metals, such as Indonesia and Chile. But it would also likely drive up the prices of everything from smartphones to homes. Businesses reliant on metals like contractors and car manufacturers could also be hurt. Such developments could cause worries about inflation across the world.

Metals markets are also notorious for having boom and bust cycles, adding to the challenge for investors focused on more immediate profits.

“You’re not going to have the mines that were recently approved [producing] until several years from now,” said Marisa Hernandez, a metals and mining research analyst at Neuberger Berman, an investment firm that oversees $315 billion. Ms. Hernandez recommends buying copper producers with a time horizon of at least one year. “That can lead to a period of time when you don’t have enough supply.”

Write to Amrith Ramkumar at amrith.ramkumar@wsj.com and David Hodari at David.Hodari@dowjones.com


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