Using Forecasting Tools to Buy Aluminum
Understanding whether aluminum price movements appear as a short-term shift or a long-term trend remains a big challenge for most manufacturers and sourcing organizations.
Market intelligence helps provide necessary guidance.
Taking advantage of short-term price movements remains a challenge because it requires a certain degree of flexibility. The more flexible an organization is, the more options it will have to implement strategies to better manage long-term and short-term commodity price movements – and that certainly includes aluminum prices.
Keep reading for a case study on using short-term forecasts to time spot purchases to lower overall category costs:
Let’s return to our example of a company that typically buys on the spot market, but holds fixed the value-add conversion cost. We’ll say the company purchases 500,000 pounds of aluminum per month (which makes it a relatively substantial buyer).
First, let’s choose a random period of time (we chose Nov. 1, 2010 to Dec. 31, 2010) to analyze what this company might have spent on aluminum if it had a short-term (eight-week) forecast:
The red line represents what the forecast would have predicted through the eight weeks if run in week 44 of 2010 (the last week of October). The blue line represents the actual LME 3-month primary aluminum prices during those eight weeks while the green line represents the average London Metal Exchange price during the months of November and December.
If the buying organization had access to the price forecast, it could have deployed the following basic strategy:
1. Buy down requirements as market falls (weekly)
2. Buy forward in week 48 or 49 thru December
Had the company followed those two steps for this eight-week time period, it would have saved $16,764. (Actual savings will vary by forecast period.)
By extending the period of study, we can analyze the savings the company would have taken over a three-year history if using a bi-monthly short-term forecast:
The red line serves as the eight-week forecast updated every two months, while the blue line represents the actual prices for each eight-week period. The chart shows both lines from July 2010 until June 2013.
By simply following the strategy explained above, on average the company would have saved $76,800/year if buying approximately 500,000 pounds of aluminum per month.
A company can also make use of a short-term forecast to create more competitive bids for its customers by:
1. Extending or shortening quotation periods (placing longer or shorter quote validities) based on the market forecast
2. Quoting more competitively by understanding near-term raw material price trends
Or if the company has the capability to hedge using financial contracts, it can use the forecast to execute futures contracts more efficiently, without having to carry extra inventory or tie up capital.
The overall value of any short-term forecast, however, will depend upon a company’s internal sourcing capability as well as the organization’s tolerance toward risk.
This is the final article in our 5-part series, How to Embed Forecasting Capability into Aluminum Sourcing Practices; click to read parts 1-4 below:
Raul de Frutos Tinoco is MetalMiner’s lead forecasting analyst. Hear Raul and other experts speak at our upcoming commodity conference: