In our last post, we suggested the most fundamental question a buying organization needs to ask (and correctly answer) is this: “Is my ________spend in a flat, falling or rising market? And whereas some would argue it remains impossible to precisely know “by how much a market may rise or fall, by understanding the direction of the market, buying organizations have deployed a range of strategies for which we will outline just a few.
In flat markets where the buying organization doesn’t believe prices will move much one way or another, we’ve seen organizations simply bid out their requirements on a quarterly basis and fixing the price to an index but locking in the fab cost (or value-add if you will).
In falling markets, the strategy above also works though we’ve seen organizations take more last minute decisions to capture every last penny of a declining price. Oddly enough, we rarely see organizations lock requirements forward as markets fall (the notion being, “we want to ride the wave down).
In rising markets, where a high risk exists of the price increasing throughout a particular quarter, we’ve seen organizations negotiate a fixed contract sometimes loosely called a resting order to hold prices steady. Larger organizations with significant spend may also have the option of hedging the underlying commodity to “arbitrage the risk so to speak between the supplier’s fixed price and the cost of a hedge. Obviously, this won’t be an option for everyone. The next questions include “how much do I lock and “for how long We’ve seen organizations take a certain percentage of spend “off the table if you will by locking in fixed price contracts for a longer period of time or for example, against confirmed or known demand. This leads us to the next point, how should a buying organization think of its buy against its sales?
Where an organization’s sales price fluctuates with underlying metals prices, such as metals distributors, unless a clear price trend is evident best practice tends to be price as close to the month of delivery as possible. This avoids the issue of having high priced metal in the warehouse in the event markets take an unexpected dip. This also works for organizations that operate on a “pass through cost basis, though its obviously less of an issue. In cases where sales prices are firm and fixed, no matter what happens to an underlying metal market, the buying organization will want to offset price risk as much as possible either through a fixed price or hedged arrangement.
In an ideal world if indexes are used (and/or required) pegging customer orders to the same index as supplier orders also mitigates risk. There are many variations of each of these strategies and we’d love to hear techniques our readers may rely upon.
In the meantime, MetalMiner will present its Q2 Steel Market Update Webinar which runs Tuesday, April 13 at 9:30 10:30 CDT and will cover topics such as market direction and strategies companies may wish to deploy for their steel categories.