QC Newsletter

January 14, 2010

More on Commodities:

Up, Down or Sideways?

We’ve seen some interesting materials trends in the past few weeks. Several of our major component suppliers have extended lead times substantially. Word is there has been enough of a pickup in business to now saturate the reduced capacities that many have planned for the year.

I worked in the components business some years ago, and I can attest to the problem of planning for business conditions that may, in some cases, extend six months out. If you guess wrong, it can take the better part of a year to recover, depending on the component.

And, customer behavior can be counter productive in an allocation market. When there are very long lead times, people sometimes place several orders for the same component. Then they plan to cancel all except one when that vendor’s first firm commitment is given. This can look like a tremendous acceleration in business to those of us who examine “book to bill” ratios.

In fact, the basic demand for the end product may have only moved up a few percent, but everyone overreacts to the stimulus and eventually pays for it in the end with large inventory overshoots. It is possible that under current conditions, where inventories have been squeezed to the minimum, that the situation can be even worse as only a modest pickup in basic demand cannot be handled without adding capacity. If demand turns out to really be accelerating, prices will soon follow.

With the economy still bouncing around the bottom and forecasters looking for modest GDP growth in the year (or years) ahead, why are some basic raw materials behaving the way they are? Is it a case of overshoot, or something else? It isn’t as if U.S. consumers have opened their wallets with unemployment still north of 10 percent.

One thought is that currency changes are the drivers. The idea is that if the dollar is in decline, it will take more dollars to buy a given material. Looking at the dollar compared with the Euro, it’s been a pretty exciting year. The year began with the dollar at about $1.40 per Euro. In the first quarter, the dollar strengthened to about 1.25/Euro but began a decline from March through early December to a low around $1.50/Euro. As of this letter, we’re back to $1.44 per Euro—close to where we began the year. So, despite all the money printing, stimulus package and low interest rates, it does not look like currency fluctuation can explain the large run-up in commodity levels.

Take copper, for example. A year ago, the spot price for copper was about $1.30 per pound. Today, it is $3.12. That’s a 140 percent increase. Gold is up 32 percent. Domestic crude oil is up 116 percent. The epoxy we buy for potting is up from $3.00 to $5.00 over the past year, largely mirroring oil. The list goes on. These increases, allowing for the volatility of spot levels, are still very substantial and far in excess of what general economic activity would appear to justify.

So where does this leave us? The only certainty is uncertainty.

 

- Jeff Cosman