We love the month of January because everyone pulls out the proverbial crystal ball to wax prophetic as to where a particular commodity market may go.
For a change of pace, I’ll leave the forecasting to my colleagues and instead, contemplate something that has bothered me immensely over these past few months: the notion of a collapse of the euro.
I have seen enough intelligence sources suggest that the odds of a complete euro collapse exceed 50 percent (some have gone so far as say that all scenarios point to a complete collapse). But before we dismiss the doomsday scenarios, perhaps it makes sense to evaluate the potential implications of a collapsed euro on the sourcing organization against a few dimensions, including: commodity volatility, currency risk, inflation risk and potential strategic sourcing strategies.
We can’t address commodity volatility without also examining inflation risk.
First, the argument supporting metal prices comes from my colleague Stuart in a recent post: “The relative strength of the US [ed note: US economy vs. Europe’s economy] will keep the dollar strong and put downward pressure on metals prices; there is an inverse relationship between the dollar and metals prices, as all metals are priced in dollars, but often consumed in other currencies.”
However, at the same time, a weakening Euro against the dollar will create buying opportunities for US and other non-European countries as commodity prices drop (of course, producers and suppliers will raise prices, but sharp buyers may strike with a hot iron!). In other words, suppliers and producers may not move pricing as quickly as the euro/dollar, Yen, etc. exchange rates move.
In fact, we appear to have a bifurcated steel market on our hands already, with US steel prices rising while European prices have begun to slip. Some experts also believe Europe will face overproduction for the next 12 months, which could create additional buying opportunities for US companies.
The real risk, however — and the risk keeping up every US treasury department these days — involves currency risk. Few feel the volatility will disappear anytime soon. But currency risk differs little from volatility seen in other commodities. We excerpt three sourcing strategies previously presented on MetalMiner involving volatile commodities:
- 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 fix the price to an index yet 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. The next step of this process includes answers to the questions “how much do I lock?” and “for how long?” We’ve seen organizations take a certain percentage of spend “off the table” by locking in fixed price contracts for a longer period of time or, for example, against confirmed or known demand.
How should a buying organization think of its buy against its sales? We will come to that point in Part Two first thing tomorrow.
MetalMiner and sponsor Nucor will host Commodity Edge: Sourcing Intelligence for the New Normal, March 19 and 20, 2012, at the Intercontinental Chicago O’Hare. Check out the link below to this new ground-breaking conference.