Continued from Part One.
So what happens with volatile currency risk?
Like commodities, currencies can move in similar ways: they can rise, fall and remain flat.
In addition, a scenario we haven’t addressed previously with commodities involves establishing strategies in markets whereby prices, at least in the short term, appear to randomly rise and fall.
Of these four scenarios (e.g. rise, fall, remain flat or move up and down quickly), we believe a falling euro and/or a volatile euro will likely dominate 2012. Based on those scenarios, US buying organizations may wish to consider several buying strategies:
- A dropping euro against the dollar with the contract in dollars — the buyer should negotiate hard at the outset for a lower price, as a declining euro will result in increased supplier profits over the course of the contract. In other words, the buyer should negotiate some sort of discount at the outset.
- A dropping euro against the dollar with the contract in euros — the buying organization may opt to price the contract in euros and then convert from dollars to euros just before payment is due to capture every last penny of a falling price.
- A volatile euro against the dollar with the contract in dollars — here, a buying organization may wish to take out a hedge (though that certainly comes at a price) and in the case of fixed price sales contracts, lock in all of the risk on the sourcing side (to protect margins).
- A volatile euro against the dollar with the contract in euros — again, depending on how the contracts appear on the sales side (e.g. USD), the buying organization may also wish to hedge the currency on the purchase side.
These obviously do not represent the only buying scenarios. Buying organizations also face extended supply chains that cross multiple countries and currencies. This presents both opportunities and risk to buying organizations.
For example, a sub-tier European supplier that sells in dollars but purchases in euros would pick up the gain in a falling euro environment. He/she may or may not pass that savings on to the downstream supply chain. On the flip side, a sub-tier supplier that doesn’t know how to hedge its currency risk properly could find itself on the losing side of the equation (e.g. if the euro appreciated against a sale in dollars).
Finally, the added complication of a global corporation with headquarters in Europe and with operating entities in the US will want to regularly re-examine in what currency it pays its suppliers to ensure against deflating profits and rising COGS.
How does this play out in metals markets?
Metals as a commodity class present special challenges because even though many of the underlying metals get priced in USD on the LME (e.g. all base metals, billet, cobalt, moly, etc.), the semi-finished processing may occur “in-country” and get priced in the local currency. Add a global sourcing scenario to that equation and one can see that having a euro currency risk strategy makes good sense.
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.