Should China's Volatility Impact Commodity Sourcing Worldwide?

This morning, I'd like to welcome Aptium Global's Stuart Burns to Spend Matters. With over twenty years of metals trading and arbitrage experience, Stuart is an expert in global direct materials sourcing, especially in metals categories. In full disclosure, I have an economic interest in his firm through my wife, Lisa Reisman, who is his business partner.

Volatility in China is no different from volatility anywhere except because of the degree to which the western world has come to rely on the forging presses, stamping works, casting plants and extrusion presses of China. We are gradually all becoming exposed to an extended supply chain and hence greater degree of risk. The recent drop on the Shanghai stock exchange will probably be seen as no more than a blip to an otherwise unyielding rise in GDP growth and investment in China. Even if some Chinese share prices have become over inflated there remains a relentless desire of a billion Chinese wanting to improve their living standards, own a house, drive a car and buy a fridge. All of which will ensure the Chinese economy continues to demand raw materials for decades to come.

Newsweek's Stephen Roach said last week "that in 2006, China's surging economy accounted for about one third the total increase in world GDP. Moreover, during the past four years, China has been responsible for about 50 percent of the cumulative growth in economically sensitive commodities such as oil and a variety of base metals, like aluminum, copper, lead, nickel, steel, tin and zinc. And, as the world's largest saver with the biggest current account surplus, China has played a major role in injecting investable funds into financial markets already awash in excess liquidity," further increasing the volatility of prices.

The problem of volatility however is exacerbated by the degree to which the price volatility has been fuelled by investors betting on the continued consumption of just one country. It is true to say that the world economy is much less of an unstable train careening down a rickety railway track and more of a super tanker steaming through the ocean. Millions of workers and hundreds of thousands of factories are not going to stop working or consuming overnight. But the degree to which funds are willing to buy commodity assets is dependent on their confidence the supertanker is not slowing or changing direction. While the supertanker will take a long time to change course the funds can unwind positions in days -- causing prices to rise or fall dramatically on their perception of a possible change.

So what can western consumers of zinc castings or aluminum extrusions do to protect themselves against such volatility? Well there are a few things and these are good fundamental steps that any company engaged in cost reduction or strategic sourcing activities should be doing anyway. First of all understand what percentage of the cost of the product you buy is directly attributable to raw material and second determine what is the value add premium due to the work your supplier puts into changing the raw material into the finished product you buy.

For example on copper alloy metal strips determine how much of the delivered price is directly based on the LME or Comex and how much is the rolling, slitting and plating value add functions the supplier provides. Once you have that figure you can quantify for every rise or fall of the Comex price or the Copper Producer Price how much the strip you buy should rise or fall. If the Comex market price drops $400/ton you can quantify how much your supplier should reduce their price for new orders.

Secondly you can create natural hedges by spreading the pricing of product you buy between spot and forward pricing. Many (although not all) manufacturers can offer spot or forward price fixing so even if you are not dealing directly with the primary producer your supplier probably is and can pass on this facility. By spreading pricing over a period of months you can even out sudden spikes and create some stability in what otherwise may be an unpredictable market place.

Watch this space for additional comments and strategies on volatile metals sourcing.

Stuart Burns is Managing Director for Aptium Global, Inc. Stuart works with small and middle market manufacturers to reduce direct materials costs and risks. He can be reached at sburns (@) aptiumglobal (dot) com.

Jason Busch

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