Articles in Category: Commodities

I can’t say that I am shocked by these survey results which were just released over the weekend by buying consortium Prime Advantage. According to the press release, of the 100 member companies that responded to the survey, 46% said that raw materials, “which include stainless steel, nickel, copper and other metals and plastics were a major concern in 2008.” Energy costs came second with 17.5% citing this as the biggest cost pressure.

Given the past two years, it is no surprise that raw material price pressures remain top of mind for purchasing professionals and owners of small businesses. What is ironic is that 66% of respondents “plan significant capital improvements in 2008, including equipment upgrades such as press brakes, turret punch presses, plus equipment for laser cutting, robotic welding and stamping”. On top of that, 59% of respondents expect a revenue boost in 2008.

But aren’t we in a recession? Well, maybe but not all manufacturing has been feeling the pinch. A colleague of mine who is a turnaround professional recently told me that he has seen manufacturing companies whom he thought would never export again, do more of that of late than in the last 10 years combined! Just last week Caterpillar (my favorite economic bell-weather) reported a 20% jump in exports of machinery and equipment in 2007, according to this Crain’s Chicago article. So it’s no wonder that we see companies worry about raw material pricing yet continue to make capital investments.

The state of the US dollar is undoubtedly a boon to many US manufacturers as their exports are now much more competitive. Foreign competition as my partner Stuart rightly points out, is down at the moment but what happens when, “they [US manufacturers] will once again face their normal level of foreign competition… I wonder how bullish they would be then?” Good point but if you are of the school of thought that the dollar had been “wrongly” priced previously due to certain “bubble” industry sectors and the dollar continues to trade as it has been for awhile, we’ll continue to see strong exports. Of course what goes up also goes down and vice versa.

But one thing we can bank on, it appears certain that raw material pricing will remain volatile and a concern for manufacturers.

Editor’s Note: If you are concerned about raw material volatility, take our free  MetalSaver quiz  for cost savings ideas. –Lisa Reisman

Note: This is part two of a two-part series discussing a recent report from Ernst & Young. Part one offers  additional insight and an introduction to the topic.

Inaccurate Analytics

The Ernst & Young report expresses disdain at the accuracy of metals price predictions, noting the disappointing errors of the past few years. The writers suggest that some metals, like nickel and copper, are hard to predict, but add, This has been, not coincidentally, a time of sustained market strength and rising metal prices over the last three years. Analysts, almost universally, have been predicting a sharp decline in metals prices to return to the average levels of the previous 10 years ¦ It is only when the mining companies are really convinced that future revenue from operations justifies the commitment of significant capital outlay that they will accept the risk, resulting in further capacity ¦ Investing just before prices plummet is a far harder mistake to survive than going along with cautious market sentiment and not making an investment.

The problem with any forecast is that it relies on forecasting tools — typically statistical models that rely on past data. These models may be better than a guess in the air, but they inherently fail to act in a predictive fashion because the utilized information has been gleaned in hindsight. In addition, it is always challenging to incorporate correct estimates of multiple factors, such as supply and demand, supply risk events which affect supply and demand patterns, technological innovation, etc. Read more

There’s an age-old adage that one thing is constant ” and it’s change. No, I’m not leading into politics and the 2008 presidential election in the States. Rather, let’s think beyond Super Tuesday and look to the metals industry. With all of the  metals industry’s longstanding practices, are there really ways for metals and metals-related processes and purchases to become eco-friendly? Rest easy, because the answer is a resounding yes. In fact, the metals industry is the vibrant host to several new ecologically aware innovations, and they might be the key to sustainable growth and development. Read more

The papers are all worrying about the power shortages being experienced in South Africa and reporting with various levels of alarm the likely impact on the price of precious metals, base metals, Ferro alloys and the stock of companies producing these materials. The reality is the recent outages in South Africa were a disaster waiting to happen. Excessive rain has made the coal reserves unusable at the plants of some of South African state power producer Eskom and power plants have been idled or on reduced production while the country struggles to share what is available.

Mines and metal smelting works have been closed this week and a limited number look set to resume working as agreements are reached with Eskom on what power it can reliably provide. The reality is this is a problem many years in the making as South Africa has  failed to tell  the whole story  over major new power plant investment and infrastructure upgrades. It is no surprise therefore that Eskom says it will be 2012 before full service can be reliably resumed. Read more

The recent power problems in China, largely caused by bad weather reported in our recent article, comes at the same time as widespread power problems in South Africa have affected Ferro-Chrome, coal and precious metal mining.

So much for mining companies, but what of the manufacturers? It is estimated that the Chinese power problems have idled up to 10% of the country’s steel production and several aluminum pot-lines. Power failures are particularly damaging to aluminum smelters because the molten aluminum rapidly solidifies in the cell, taking months to get the cell operating again at a very high cost. So if power is likely to be disrupted, smelters usually voluntarily take pots out of operation to reduce the demands on the grid and ensure reliable supply for those cells left in operation. That is what is happening at Southern Africa’s three smelters, Bayside 190kt, Hillside 709kt and Mozambique’s Mozal 564kt following warnings from South Africa’s power generator Eskom that due to heavy rains they can’t guarantee power supply for the next 4 weeks. We have heard that due to under investment there will be intermittent cuts for the next 4 to 7 years! In addition, expansion plans at Mozal and Hillside and the proposed new Coega smelter of 700kt are all in doubt according to Standard Bank, Leon Westgate, Base Metals Flashnote, 29 Jan 2008. Read more

I received a phone call last evening from a friend in Shanghai. He had asked me if I heard about the power shortages and energy crisis in China. Oddly enough, I had been planning on writing a short piece on how power shortages were having an impact on various metals markets. In China, the country’s largest aluminum producer shut down operations at two plants in Guizhou and Zunyi, according to this recent article in Forbes. With annual production of “320,000 and 110,000 tons respectively”, the loss of this production is bound to have ripple effects in the Chinese and possibly wider markets. No date has been set for when the plants will begin production again. The effect on aluminum prices coming out of China remains to be seen. I have read that the prices of alumina, will drop due to lack of demand but the cost of primary aluminum or semi’s may increase. Read more

No Luxury Ride for Rolls-Royce

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In a determined effort to cut costs, Rolls-Royce PLC recently announced plans to dismiss 2,300 workers, nearly six percent of the company’s approximately 39,500 international employees. Workers in the U.K., the U.S., Germany, and Nordic countries will most feel the sting, according to the Wall Street Journal. The  U.K. jet-engine maker  seems to be faring well, with a hefty number of recent orders, but London analyst John Middleton of Cazenove reported that these job cuts are expected to reduce overall operating costs by several million dollars. It’s really about improving efficiency and competitiveness on the part of the company, Mia Walton, a Rolls-Royce spokesperson, told the Canadian Press. It is reported that the cuts, which will focus on managerial, professional, and clerical positions, are meant to improve productivity and offset the impact of a U.S. weaker dollar and higher raw material costs.

There are very few —  if any —  ways for companies to combat both high-cost metals and other problems that develop when certain metals are difficult to procure.  Unfortunately, these raw materials can rarely  be replaced in  Rolls-Royce products and several other products on the market. This necessity poses a dilemma, since prices of aerospace metals such as cobalt, nickel, titanium, and rhenium are still on the rise, while rhenium, cobalt, and tantalum remain in short supply. Titanium alloys, nickel alloys, and composites have been scarce for quite some time. For the world’s second biggest maker of commercial airplane jet engines, the properties in these metals are not expendable, Leon Grabowski, sourcing specialist at Rolls-Royce, said last April in a Reuters article . Once [an aircraft engine] is designed, tested, flown in, it’s almost impossible to take [various materials] out, Grabowski explained. Instead, Rolls-Royce and other companies must continue to purchase these expensive materials, making further layoffs in the sector more likely as raw material costs remain elevated. Read more

At the same time that respected Wall Street guru David Rosenberg, Chief Economist at Merrill Lynch declared that in his opinion the US is actually in the first month of recession, we came across a wonderfully upbeat report on the prospects for the world economy in Britain’s Daily Telegraph that we wanted to share with you as you pondered the falling value of your house and impending tax return.

Tom Stevenson, often noted for his insightful and contrarian views, noted a report by the research group Iris for fund managers Robeco on the subject of scarcity as a theme for investment. Some of the findings may on reflection not come as a great surprise individually but looked at cumulatively they paint an astoundingly positive picture for companies able to position themselves to offer products or services identified as being in high demand.

The background briefly is that the world is fast moving from being an agrarian, dispersed population of some 2.5B in 1950 to 6.5B today and 9B in 2050, 85% of whom will be in what are emerging markets today. Well before then, over 60% will live in cities where their newly resource hungry lifestyles will require an explosion in demand of commodities, water and energy. Per capita consumption of energy in China is comparable with S Korea and Japan at similar stages of their development. If China follows a similar path, its demand for energy will rise 10 fold in the next 30 yrs. Calamity you say, opportunity says Stevenson ” for human ingenuity and creativity to find solutions to water scarcity, energy consumption, pollution and food supply. Specifically these are the certainties identified:

¢  Demand for industrial metals will outstrip supply. China currently uses a third of the copper per head compared to Europe or North America., but by 2030 China, Mexico and not far behind India will have living standards closer to Spain today, nearly 3B people with a metals demand to match. Just look at the effect car consumption will have on copper demand. Currently mining companies as a whole spend only 5% of their profits on exploration. With demand outstripping supply, exploration will have to increase.

¢  World energy demand will be 50% higher in 2030 than today. Both oil and alternative energy prices will remain high.

¢  Food prices will continue to rise, both for human consumption and for feeding cattle. Meanwhile bio fuels targets will mean 12% of the world’s agricultural land will be needed for transport compared to 2% today.

¢  The WHO predicts 35% of the world’s population will be in water stressed areas by 2025, the non economic pricing of water will have to change.

¢  Air pollution will get worse but so will the opportunities for companies providing solutions. The market was US$60B last year and is forecast to double in five years.

So there is plenty of growth out there, once we raise our sights to look beyond the housing market and the availability of short term credit.

–Stuart Burns

Are We Headed For The Middle Ages?

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I read a fascinating article the other day by Ambrose Evans-Pritchard for the Sunday Telegraph The Sunday Telegraph (the slightly stuffy Sunday edition of Britain’s best quality paper the Daily Telegraph). My father worked for them for 20 years and banned the reading in our house of any other newspaper  — a rule that still holds sway to this day. Anyhow, the article was regarding the gold price and where the true value should lie. Mr Pritchards’ suggestion was that due to a combination of steadily dwindling world production, rising consumption and the flight to a safe haven as governments devalue their own currencies by flooding the world with cheap money we may be heading for a Gold price closer to $3000/ounce. Apparently this was the price of gold for much of the Middle Ages, adjusted in real terms, only falling when Spain began to flood Europe with gold plundered from the Inca and Aztec civilizations. Since then, at least for much of the 1800-2000’s it averaged $630/ounce in real terms.

Gold has been one of the hardest of the metal prices to call during the last 2-3 years. It has clearly benefited from the relationship the commodity funds put between oil and gold, typically buying 35% gold for every 65% investment in oil. As oil has been bid up so has gold.Needless to say not everyone supports Mr Pritchards’ ideas (tongue in cheek as they are) UBS’ John Reade suggests gold is overvalued by some $150/ounce but that in itself doesn’t mean it will fall. Over the short term it is driven by sentiment not fundamentals.

And just to show how the best research departments can get it wrong Goldman Sachs advised clients in November to short gold following which it moved up $60/ounce! So while a return to the Middle Ages is unlikely, consol yourself with the thought that it would appear that even the best minds in the business can’t agree on where gold will be heading next.

–Stuart Burns

A wise colleague once told me the first time you hear something, it’s a data point. The second time you hear it, it’s a line and the third time you hear it, it’s a trend. Said differently, the demand for the world’s precious raw materials is going to increase and so too will the prices.

Though we stand by our 2008 metals predictions (including copper) – the fact remains the underlying data may be pointing to a very different financial picture long term. Consider the following:

  • Tata Motors just unveiled their $2500 car for the Indian (and other) markets
  • Examining per capita “consumption rates” as recently published in the The New York Times by noted professor and author Jared Diamond, “The estimated one billion people who live in developed countries have a relative per capita consumption rate of 32. Most of the world’s other 5.5 billion people constitute the developing world, with relative per capita consumption rates below 32, mostly down toward 1.” But, “China’s catching up alone would roughly double world consumption rates. Oil consumption would increase by 106 percent, for instance, and world metal consumption by 94 percent.” And we haven’t even talked about India or any other developing country.
  • According to a March 2007 article quoting Sanford C. Bernstein, an investment management firm, a hybrid car, “costs US$4,500 to $6,000 more to build than a conventional vehicle.” Some of this cost is due to the added metal content for a hybrid vs a regular car. For example, there is more copper used because of the electrical motor and the larger the motor, the more copper required. In addition, more nickel is also used in hybrids than in conventional cars. And, according to this same article, the automotive industry accounts for 5% of global copper usage.

And the data goes on and on…though the metal content of cars has historically been dropping as a % of the overall content of a car (and electronics has risen), metals consumption overall will increase exponentially as more of the lesser developed world purchases cars.

Of course all of these data points examine the demand side of the equation. We’ll come back to the supply side in another post. But consider this odd trade agreement as reported in The New York Times between Chile and China hint: Mandarin lessons were part of the accord. China is busy brokering long term raw material, in this case copper, supply arrangements. The long term writing may be on the wall.

–Lisa Reisman

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