Commodity Prices: Nowhere to Go But Up (Part 2)

In the first post in this series, I relayed some of the highlights from a post that analyzed equity research analyst Jeff Saut's take on commodity and related inflationary pressures we're already starting to see. The full text of his research abstract, which you can read here, begins by describing the story of one of Saut's contacts in the industrial world and his firsthand experience with rising prices. Saut quotes that his contact, a "large volume importer of industrial hardware" primarily from Asia, notes, "just received my April ocean freight rate update. Container cost up 5% from March and up 21% from April 2009. For my products, the YOY increase represents a 3% increase to cost of goods. Cost of steel as we know is going up significantly and these price increases for us -- contrary to what the popular spin may be -- are effective immediately ... Anyone who tells me that there is no inflation on the horizon is delusional and in for one hell of a shock."

The rest of the brief highlights a range of macroeconomic and investment theses, while also providing proof that inflation has already begun. Consider that since "January 2009 the price of copper is up ~185%, crude oil is better by ~118%, and rubber is higher by ~167%. Moreover, from August of 2009 until now hog prices have rallied ~75%, while cattle prices have lifted ~19%. Such actions caused the Reuters CRB Commodity Index to travel above its 200-day moving average in June 2009 and stay there ever since (read: bullish and inflationary)." Saut goes on to suggest that inflation is actually a tool of our government, noting that in past research, he suggested "that a 10% per year inflation rate, for the next five years, would go a long way in solving the nation's debt problems."

There's historical context for this analysis. Saut quotes another market observer who notes, "in 1979 the government ran a deficit of more than $40 billion -- about $118 billion in today's money. The national debt stood at about $830 billion at year's end. But because of 13.3% inflation, that $830 billion was worth what only $732 billion would have been worth at the beginning of the year. In effect, the government ran up $40 billion in new debts but inflated away almost $100 billion and ended up with a national debt smaller in real terms than what it started with."

As a result of what looks like a repeat of 1979, procurement organizations should look to establish deeper visibility into their overall raw material price exposure at all levels of their supply chain. As one solution, procurement teams should consider potential demand aggregation strategies not only from a cost avoidance perspective, but also to insure continuity of supply throughout their tier two and tier three suppliers as well. I'd also suggest learning about all of the hedging, forward-buying and other options available -- not to mention their tax, inventory and related implications (e.g., when you can use hedge accounting vs. not and its impact on the balance sheet).

Jason Busch

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