News focus: Speculate to accumulate

7 December 2012

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11 December 2012 | Anna Reynolds

Should you pin down long-term commodity deals now, hedge or hang on until later? Anna Reynolds asks the experts.

Bad news: buyers believe commodity prices will continue to increase throughout 2013.

A recent survey by consultancy AT Kearney reveals the outlook is bleak, while concern over securing natural resources was highlighted as one of the biggest fears facing the global economy in a report by the World Economic Forum.

However, analysts are more optimistic. Tom Bundgaard, chief analyst at Kairos Commodities, says: “There is a huge correlation between the Purchasing Managers’ Index (PMI) and commodity prices. At the moment the PMI [globally] is falling – it has been below 50 for a while. As long as the economy contracts, commodity prices will contract.” 

Bundgaard explains that fluctuations occur depending on commodity type. Currently, soft commodities such as corn and wheat are at a peak following droughts in the US over the summer. However, the price of metals is falling and analysts are prompting buyers to act.

Speaking at a webinar last month, John Anton, manager of the IHS Steel Service, urged buyers to take advantage of low steel prices. He said: “China was expecting 10.5 per cent growth, but only achieved 7.6 per cent. Therefore, it over-invested and over-produced.”

The surplus of steel signals a good time for buyers to secure long-term contracts. Oliver Dreier, vice president and EADS lead buyer at Airbus, is doing just this. “We have engaged with our titanium suppliers in long-term contracts until 2020 and are working on securing similar contracts for steel.”

He says the company’s long-term strategy is to secure business and ensure aircraft delivery for 2015-2020 as order books are “pretty full”. So long-term deals are more attractive. “What we need is stability. I know exactly what my prices are for most materials for 2013 to 2015 as they are the same I pay today. We feel we have a good price, but I don’t know what the market will look like in 2018.”

After carrying out a forecast in October, Airbus came to the conclusion that prices will rise in 2013. “We are influenced by alloy elements, which can be nickel, copper or aluminium-based and the tendency is for these to go up,” says Dreier.

Bundgaard describes a “psychological fear” among buyers when prices are high and a tendency to lean on static models of anticipation. “It is important that buyers act on dynamic signals. If they see a turn in the PMI or a three-month upward correction for a particular commodity, they need to react quickly by short-term hedging.”

According to Bundgaard, all commodities will need a short-term hedge (one to five months) at some point during 2013 and he recommends buyers avoid medium- to long-term hedging to gain benefits of falling prices and reduce risk.

Jeremy Bowley, procurement director at Miller Construction, says that historically, hedging doesn’t take place in the construction industry, with most risk passed on to subcontractors who buy on behalf of firms. However, looking to 2013, Bowley says he will expose the visibility of commodity costs and exploit the falling market. “This gives us an opportunity – we are all hungry to take costs out of our supply chain so I will be quite relentless in pursuing this,” he says.

While this is a common approach to take to market, analysts have raised concerns that measuring risk is too advanced for many buyers.

Dreier says different approaches are taken to protect against market volatility and two years ago he started hedging for aluminium, which is “going well”. Similarly, Martin Wakelin, purchasing director at Trelleborg Sealing Solutions, says: “We have a lot of data available at group level of trends each month and produce raw material reports that include buying recommendations.” 

Wakelin adds: “I learned early on that you can’t beat the market. We are purchasing people, not traders. It’s my job to track the market and provide as much certainty as possible.”

Trelleborg buys three key commodities, rubber, fabric and metals, and has just completed the budget process to secure the position for 2013. “We have put in flat prices for next year on most commodities with moderate increases on some of the rubbers we buy,” says Wakelin.

However, he says delays in the supply chain mean price movements can be hidden, making it difficult to hedge. “We are expecting there to be downward pressure on steel, but we may not see it until later in the year.” 

Analysts Capital Economics has released its forecast for the coming months and, despite some exceptions, the overall picture shows a downward trend. Julian Jessop, chief global economist and head of commodities research at Capital Economics, says: “Recently, commodity prices have been weaker and I expect this to continue over the next five to 10 years as developing economies become more efficient in their use of commodities.”

However, buyers remain cautious. Dreier says: “In my perspective, it is unlikely the market will drop. The overall trend for raw material prices can only be upward because we are speaking about limited resources.”

Capital Economics notes that US natural gas has experienced a significant drop in price following a mild winter and the introduction of shale gas. Jessop expects prices to climb over the next few months as gas producers will need to charge higher prices to remain in business.

Meanwhile, coal prices are forecast to remain low because of a mining boom in Australia and Indonesia, and a steep fall in demand due to environmental pressures.

According to Jessop, even the agriculture commodities market hasn’t suffered as badly as buyers think. While the droughts in North America have affected prices of wheat and corn, those of sugar, cotton and coffee have done better than expected. But Mark Hughes, group procurement director at Premier Foods, says: “Input cost inflation has returned in some major categories. This is not just a temporary situation as sowing of cereal seed for harvest 2013 is behind plan, due to our current weather. Whatever hedging mechanisms you have, over time you still have to pay market prices.”

Jessop says commodity prices have been pushed up by speculation: “People are buying commodities because they want to speculate on the price. We have seen huge inflows into commodity investment funds, but pouring money into a market doesn’t push prices up.”

On the surface, low prices suggest an advantage for buyers. However, it could also mean underlying problems. Jessop warns: “If commodity prices are falling because supply is improving and speculative pressure goes away, then this is good news for buyers. But if prices are weak because the world economy is sliding into recession, then it’s a silver lining on a pretty big cloud.”

Analysts’ top tips for buyers

● Julian Jessop (chief global economist and head of commodities research at Capital Economics): “If you permanently need to buy commodities, you should hedge your exposure as much as possible to protect your position. I wouldn’t advise anyone to bet their business on whether prices are going up or down.”

● John Anton (manager of the IHS Steel Service): “Steel buyers should look to cheap markets in East Asia, Turkey and southern parts of the EU. Saudi Arabia and North America are good to buy chemicals and natural gas. As for copper prices, these should start trending down six months from now.”

● Rod Sherkin (president of Propurchaser): “Don’t get caught in the trap of guessing something – the commodity market it is a lottery. When I was vice president of supply chain at Pillsbury [the company behind the Green Giant brand] my team became responsible for leading the process that came up with the forecast. We would bring all the data to the table and come up with a general consensus.”

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