Infrastructure has been in the news a lot lately, with both US Presidential candidates talking about significant spending programmes to improve the state of US infrastructure. But what does this mean for investors?
Public infrastructure is a term used to describe a wide range of long-life assets that serve a public good, and can include roads, railways, bridges, airports and water systems. The economic benefit of public infrastructure investment can be significant, boosting short-term growth as money flows into the economy, and in the long-term it can increase productivity for the overall economy, as it allows more goods and services to be produced with the same level of input, fostering long-term economic growth. For businesses, it can help to lower fixed costs of production, especially transportation costs, whilst for households, a wide variety of final goods and services are provided through critical pieces of infrastructure, such as water, energy, and telecommunications.
Throughout the first half of the 20th century, major infrastructure investment occurred in the US and Europe, driven by government spending programmes such as FDR’s New Deal and efforts to rebuild Europe after World War II. These programmes delivered exceptional economic growth, but upon their completion, infrastructure spending rates began to trend downward, with the US spending 2.5% of GDP on non-defence infrastructure in 2016, down from a peak of 4% in the 1960s. This underinvestment led the American Society of Civil Engineers to rate the US a D+ on its 2017 Infrastructure Report Card.
At the same time, rising globalisation and demographic trends went hand-in-hand with infrastructure spending to drive spectacular economic growth in emerging markets over the last couple of decades, led by China. Within these emerging markets, urbanisation has been a significant driver of infrastructure investment, as a largely rural population migrated to the cities. Urbanisation in both developed and emerging markets has led to the creation of megacities, that by some estimates are the source of 66% of global economic activity and 85% of innovation.
All of this building has required huge amounts of basic metals, including iron ore (used to make steel for buildings and structures) and copper (used for conducting electricity). Over the last century, the world’s annual crude steel production has grown from around 60 million tonnes (Mt) to more than 1.6 billion tonnes (Bt), with much of the growth occurring in two key periods – the 35 years after World War II and the China-driven boom since 2000. For the period from 2000 to 2010, the compound annual growth rate of China’s steel output was over 17%!
In the long term, the demand for iron ore and copper looks set to benefit from these ongoing trends of urbanisation in the developing world and emerging market growth. At the same time, supply appears largely constrained, given declining production grades at many of the world’s mines, a lack of new deposit discoveries, and the long time it takes to bring a new mine up to full capacity. As such, we remain positive on the long-term outlook for iron ore and copper.
In the short-term, there are further reasons to like these two commodities. Plans for a new wave of infrastructure spending in the US and Europe have grown in acceptance over the last few years, especially surrounding the “green” infrastructure that is required to manage the transition towards a low-carbon economy, which we have written about extensively in previous weeks. These calls have only grown louder with the disruption caused by COVID-19, with policymakers looking for fiscal stimulus to boost national economies. In particular, a low-carbon economy will run on copper, for example to connect smart grids that are supplied by renewable energy sources, and to enable electric transportation systems, further boosting demand for the copper.
In addition, record low interest rates around the world alongside expansionary fiscal policies have set the stage for inflationary pressures in the medium term, which typically bodes well for commodity prices.
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