by Dr David Clark*

In Australian markets, booms in resource shares have been the best times to make a quick buck and the last couple of years were a good reminder of this maxim.

Take the spectacular share price run by Australian Mining Investments, the value of which soared almost 25-fold between May and early July this year.

But few investors - or their advisers - even get near the racetrack where such dashing fillies perform.

Still, the draught horses have also performed very well indeed. In recent months, gold hit a quarter century high, copper and zinc prices reached record highs, and other base metals have hovered near multi-decade peaks.

The big question now is whether there will be another sharp correction this time round or, as some analysts are arguing, this boom is very different to past ones and thus will display much greater longevity.

In assessing this claim, it is first important to remember what moves commodity markets and never forget that commodity market ups and downs are always very poorly predicted.

For example, a few months ago, the consensus forecast was that Australia's mining company profits would fall 3 per cent in 2006-07. They are now expected to rise by over 10 per cent. Even a week is a very long time in forecasting such markets.

What usually drives commodity prices upwards? The key factors include:

• Strong industrial growth, particularly in the US and China. Aluminium, lead, iron ore and copper prices usually lead the upswing.
• Strong demand from other newly-industrialised economies in East Asia.
• Run-downs in stocks and falls in supply. For example, the current world shortage of refining capacity has helped push oil prices higher than they would be otherwise.
• Changes in investment preferences. For example, the recent rise in gold prices has partly been a product of a world-wide increased interest among investors in holding gold.

Conversely, what usually produces price falls? The key factors include:

• Expected falls in industrial growth in the major economies.
• Too much of a commodity currently being supplied, relative to demand. For example, the fall in the gold price over the 1990s was partly a product of a very sharp rise in production.
• Dumping by suppliers of unexpected quantities of a commodity on world markets. For example, the Russians dumped huge quantities of aluminium on world markets in the early 1990s, sending down its price sharply.
• In the longer-term, technological change - by lowering costs of production - can also push prices downwards.

Will there be a sharp correction over the next year?

Most analysts do not expect one. For example, the Australian Bureau of Agricultural and Resource Economics' latest forecasts do not predict anything like a price slump for any of the major commodities we export.

World steel production is expected to keep growing strongly, thus preventing a sharp fall in iron ore and coal prices, although in recent months they have come off their record highs.

It also expects the gold price to keep rising and copper, nickel and aluminium prices are also expected to do likewise.

Much more bearish commentators believe that commodity prices have peaked and will now fall somewhat, largely owing to higher interest rates in many Western economies, which will slow spending and investment and hence the demand for key industrial inputs.

However, Asian economic growth - and most importantly Chinese demand for industrial commodities - is likely to remain strong over the next year, putting a solid floor under most commodity prices.

Looking further out though, the halcyon increases in Chinese manufactured exports cannot be maintained and only a boom in Indian demand for key industrial commodities will be able to prevent some correction.

We are thus unlikely to see a sharp correction in commodity markets over the next year but certainly don't expect similar, skyrocketing returns like those of the past two years to continue indefinitely.

As the grey-haired investment adviser rightly warned their wet-behind- the-ears graduate colleague:
"Near vertical market graphs never stay tumescent."

Dr David Clark teaches Business Economics at the University of NSW and is an investor educator.