Materials Risk

Euro Breakup - Drachma by end 2012?

Sun, 13 May 2012 16:24:51 -0400

Despite reports that a number of Britain’s biggest bookmakers had stopped taking bets on ‘Grexit’ there are still a number of markets available from other bookmakers (Paddypower and Stan James) and through betting exchanges (InTrade). The first observation is that the markets are defined in very different ways and so comparing odds between bookmakers/exchanges is a bit like comparing apples and pears. Announcing an intention to leave is very different to actually leaving, let alone introducing a new (or old!) currency! Greek currency on 31 December 2012? Euro 4/7 Drachma 11/10 Any Euro country announcing intention to drop Euro before… End 2012 3/2 End 2013 Evens End 2014 1/2 Eurozone to breakup by 2015? Yes 1/5 Germany is the third favourite to be the first country to leave the Euro at 12/1. Angela Merkel’s election defeat on Sunday (13 May) taking place in North Rhine-Westphalia (Germany’s most populous state) is likely to lead to increased pressure on the current policy of austerity. However, its a stretch to see a complete collapse in German political support that would result in it leaving the Euro any time soon. First country to leave the Euro? Greece 1/4 Spain 7/1 Germany 12/1 Italy 12/1 France 14/1 Ireland 14/1 Portugal 14/1 Finland 18/1 Austria 22/1 Cyprus 22/1 Belgium 25/1

Euro exit probability rises above 50% following Greek election

Mon, 07 May 2012 05:07:00 -0400

Euro exit probability rises above 50% following Greek election:

The probability of a country announcing its intention of leaving the Euro before the end of 2014 spiked upwards following the Greek election rising to 56%, the highest probability since early 2012 (see Intrade market here). Citigroup estimate the probability of a Greek exit from the Euro at between 50%-75% over the next 12-18 months. As Ed Conway tweets, Greek share prices have plunged to the same level that Merkozy suggest a country might leave the Euro.

The plunge in Greek share prices this morning. Down to lowest level since Merkozy suggested country might leave euro twitter.com/EdConwaySky/st…
— Ed Conway (@EdConwaySky) May 7, 2012

Economic risk sentiment changes away from Greece and towards oil

Sun, 26 Feb 2012 19:17:06 -0500

The chart below shows global web searches through Google for ‘greek default’ and ‘petrol prices’. As the blog Sober Look explains there has been a noticeable shift in public perception of risk during February with fear of a greek default replaced with concern over rising oil prices (manifesting in higher petrol (gas) prices and fears over the impact on economic growth).

However, as Materials Risk has highlighted in its Friday links Don’t pay attention to the news!” there is a danger for investors but also for businesses and policymakers in their attention being drawn to the latest dire economic news item with quanitifiable impacts and away from the underlying but perhaps unquantifiable risk lying beneath them. As The Economist points out this week when it questioned why a room full of CFO’s were so sanguine about a Greek exit from the Euro sometimes theres “nothing to fear but the lack of fear itself”.

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Chart of the week: The power of the weather to skew statistics; US industrial production down due to mild weather reducing demand for coal

Thu, 23 Feb 2012 16:10:16 -0500

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Friday links: Don't pay attention to the news!

Thu, 23 Feb 2012 15:53:56 -0500

- Is careless talk costing our economy?

- Media Headlines Will Lead Investors To Ruin

- This crude oil rally may turn out to be short-lived

- How and Why Greece Will Leave the Eurozone

- When will China emerge from the global crisis?

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China economic and environmental briefing: China welcomes the Dragon… But has this one lost its fire?

Thu, 23 Feb 2012 15:45:32 -0500

This week marked the release of the first piece of economic data illustrating the strength of China’s economy in the year of the Dragon. HSBC’s Flash PMI, published on Tuesday (coming a week before the official Chinese government PMI) gives an early indication of the strength of the country’s manufacturing sector. The PMI index rebounded slightly to 49.7, up 0.9 from January as factories begin to start work again but importantly marks the fourth consecutive month where manufacturing activity is contracting.

The PMI data also showed export orders falling to an 8-month low. Only two weeks ago Chinese customs data revealed that the country’s exports fell 0.5% in January from year earlier levels, the first decline in more than two years. So how much of this weak data can be attributed to the Chinese New Year? Well in 2012, the Chinese New Year holiday fell on 23 January, the earliest since 2004 pointing towards January’s economic activity being more subdued than normal. Now almost one month since then, reports of labour shortages abound as migrant workers fail to return to work, this exacerbating the impact of the Chinese New Year on economic activity well into February. Cities such as Beijing, Shenzhen and Guangzhou are still short of hundreds of thousands of workers, Shandong province alone is missing one-third of its workforce.

While weaker manufacturing output and export order books can be seen as a reflection of the broader slowdown elsewhere in the world, particularly Europe, the 15.7% fall in imports in January can not just be attributed to weak overseas markets and the Chinese New Year. Softer domestic demand is likely to have been a factor as the property market and domestic investment cools.

What can China do to help support the domestic Chinese economy? Well to a large degree that depends on what will happen to inflation. Chinese inflation jumped to 4.5% in January, up from 4.1% in December and breaking a streak of five consecutive months of lower inflation. In the short term inflation is likely to moderate further over coming months as the impact of the Chinese New Year falls away. Indeed the Peoples Bank of China, the country’s central bank took the opportunity to lower the reserve requirement ratio of banks by 50 basis points (as of 24th February), potentially freeing up $64bn of new lending. As an analysis from The Economist pointed out, China of all the emerging economies is in the top 5 in terms of capacity for further monetary and fiscal policy easing, so called “wiggle room”. Expect more signs of easing in coming months.

Attention in recent weeks has also focused on the countries wage levels, especially the company Foxconn, who as a key supplier to Apple recently raised salaries at their Chinese factories by 25%. The Chinese government, as a matter of national policy, has been increasing minimum wage levels by 15 percent to 25 percent annually for the past three years with different provinces able to alter their wage according to local needs. Although wages are increasing at a faster rate in the coastal manufacturing areas than the interior, rising living costs in cities such as Shanghai mean that many migrants find they are better off staying closer to home.

US scientists have used satellite data to create the first estimates of ground level particulate pollution in China. Particulate concentrations are the highest in Shandong and Henan provinces. Unsurprisingly, less developed western provinces such as Tibet and Inner Mongolia have the lowest fine particulate matter concentrations. Beijing, Shanghai and Guangdong province have experienced slight decreases in particulate levels over the last three years, although concentrations have remained fairly steady over the last nine years. Indeed the decline since 2008 will be partly due to economic activity in certain regions but also due to government efforts to shutdown ageing and inefficient manufacturing facilities.

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What is the main economic risk your business is planning for in 2012/13?

Fri, 17 Feb 2012 17:39:26 -0500

[polldaddy poll=5954102]

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Friday links: No Greek fairytale

Thu, 16 Feb 2012 17:44:01 -0500

- The Uptick’s Downside

- How an economist says “I love you”

- IMF China Economic Outlook

- Just as Greece complies at last, Europe pulls the plug

At Materials Risk we are always keen to ensure we provide our readers with content appropriate to their needs. We would be very grateful if you could help by taking part in our poll ‘What is the main economic risk your business is planning for in 2012/13?’

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Chart of the week:skyscraper booms vs economic crisis; time to be wary of China and India?

Thu, 16 Feb 2012 17:28:04 -0500

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KPMG expect the unexpected: what lessons can be learnt for commodity risk management?

Wed, 15 Feb 2012 13:27:12 -0500

A new report from KPMG identifies 10 global megaforces that are expected to significantly affect businesses activity in a range of different industries over the next 20 years. With businesses operating in an ever more interconnected world where supply chains are stretched across continents and vulnerable to disruption changing consumer demand, government policy and volatile resource and environmental factors can significantly impact a businesses bottom line.

The KPMG analysed more than two dozen forecasts from international agencies, think tanks and national agencies to identify those changes likely to have the greatest impact on business. The ten ‘megaforces’ identified were climate change, energy and fuel, material resource scarcity, water scarcity, population growth, urbanization, wealth, food security, ecosystem decline and deforestation.

Although all inter-related, the report identifies climate change as one global megaforce that directly impacts all other ‘megaforces’ listed previously. The six types of risk to business from climate change identified included; physical risk, regulatory risk, competitive risk, social risk and litigation risk. In terms of a businesses ability to commodity risk manage, physical risks are key. Physical risks from climate change include contamination of groundwater supplies, water shortages, lower agricultural yields and extreme weather. It should be noted that all of these are happening right now and are impacting businesses bottom line.

The KPMG report expects commodity markets for energy and raw materials (the key area that Materials Risk aims to help business to manage) to become more volatile and unpredictable because of higher demand and changes in the location of consumption, supply and production uncertainties and increased regulatory interventions related to climate change. Resource scarcity and volatility are difficult business challenges but they may also offer opportunities, if successfully managed to reduce risk and become more successful relative to the competition. The report concludes that “Companies need to develop resilience and flexibility for this unpredictable future and build capacity to anticipate and adapt. Good management used to be about preparing for the expected, now it is just as much about preparing for the unexpected. To thrive, or even just to survive, businesses increasingly need to understand the root causes of what affects their operations, not just the symptoms”.

To get businesses thinking about the risks their company is exposed to and understanding the root causes of what affects their operations, the authors developed a nexus approach; described below. Although illustrating an increasingly complex world the report suggests that to begin to understand will help identify risks and foster innovation.

1) The Footprint Nexus: the forces driving the escalating “footprint” of mankind on the planet
2) The Erosion Nexus: the resulting changes in the natural systems on which we depend
3) The Innovation Nexus: the opportunity to address sustainability challenges through business innovation

The report concludes with an analysis of the current readiness to these ‘megaforces’ on a sectoral basis. Although several industries have made successful strides in reducing their exposure to climate and commodity related risk more can and needs to be done.

[gview file=”http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/building-business-value.pdf”]

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Friday links: Chinese growth migrates inland and technicals point to caution!

Thu, 09 Feb 2012 18:31:24 -0500

- What’s Behind the Sinking Global Shipping Sector?

- Chinese GDP by province

- Technical indicators point to need for caution

- Electricity price gyrations boost power trading

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Chart of the week: Peripheral Euro-zone weighed down by debt

Thu, 09 Feb 2012 18:23:48 -0500

Source: OANDA

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Cotton Price Forecast - Materials Risk 3 Month Outlook

Mon, 06 Feb 2012 04:00:57 -0500

Developments in the cotton price over the next three months are likely to be heavily influenced by drought in Texas and Chinese cotton reserve purchases. However, with cotton one of the most sensitive commodities to the global economic climate and the increased speculative interest in cotton by non-physical funds the cotton price may be more reactive to the outlook for the 2012/13 crop season and the latest economic data releases.

Background

US cotton futures prices slumped to 85c per lb in mid-December, down from 154c per lb at the same point in 2010 and down from over 200c per lb back in March 2011. Cotton futures fell during November and December after estimates of global cotton production for 2011/12 were revised upwards. However the onset of drought in Texas, a key cotton producing area, due to the la Niña weather pattern, Chinese purchases of US cotton for its own cotton reserve and forecasts of reduced cotton production acreage in 2012/13 have supported prices since then.

Surge in bullish speculative cotton positions

Speculative interest in cotton futures has increased since mid-December with CFTC reporting net long positions rising from 8k contracts to 30k contracts as of end January with open interest rising by 15% (see latest Commitment of Trader report here). In the last few weeks it has reported that significant speculative funds have entered the market with target prices of $1.18-$1.20 per lb by July.

The timing of the surge in speculative interest coming in anticipation of the announcement late January that the US Federal Reserve would publish its interest rate forecasts for the first time. In reality the Federal Reserve stated that benchmark interest rates will remain ‘exceptionally low until at least 2014′, a year of ultra-accommodative monetary policy more than the market expected which was bearish for the US dollar but bullish for commodities.

Data from the CFTC revealed speculative positions on rising commodity prices rose 9.3% in January, the fastest rate of increase since January 2006 and the highest net length (bullish positions) since November 2011. Indeed cotton isn’t the only commodity to have seen a rebound in prices during January. The Economist commodity price index shows prices have increased by 4.1% during January with industrial commodities rising by 11.3%.

Upside surprise to economic data since January supporting bullish sentiment

Since the start of 2012 there has been a raft of economic data releases from key cotton markets around the world. Broadly, data from Europe, China and particularly the US have surprised on the upside. In Europe, manufacturing PMI data point towards an improvement in economic conditions during January, even suggesting the Eurozone may have avoided recession during 2011Q4. Meanwhile in China, despite representing a slowdown from 9.1% GDP growth in 2011Q3, 8.9% GDP growth in 2011Q4 came 0.2% higher than analyst expectations. In the US the jobless rate fell to 8.3% in January (a 3 year low) while GDP growth came in at 2.8% in 2011Q4 up from 1.8% in 2011Q3. The Citigroup Economic Surprises Index for major economies which measures actual economic data versus consensus expectations rose by over 50% since the start of the year.

Chinese buying on the dips to fill reserve

China maintains a strategic reserve of cotton in order to keep its domestic textile mills operating. During the first half of 2010 those reserves reportedly dropped to low levels and ever since the Chinese have been buying cotton to gradually build those reserves back up. Estimates vary as to how much cotton they have bought with some market participants estimating that China has bought around 12 million bales and are likely to buy another 6-8 million bales over the next few months (over and above their current domestic needs) in order to rebuild their reserves. Recent market activity has suggested anything below $1 per lb has been met with Chinese buying. Once the reserves are fully replenished later in the first half of 2012 however, one of the key recent price supports may wane.

Drought in Texas set to continue to be supportive

The onset of la Niña has brought dryer than normal weather conditions to the crop producing regions of Northern and Southern America. In the US, the southern crop producing states have been particularly affected with drought conditions in cotton producing Texas currently described as extreme or exceptional. The latest seasonal assessment forecast from the US National Weather Service covering the period 2 February to 30 April 2012 expects drought conditions to persist over the southern states for the next 3 months. The current drought conditions and expectations of it continuing may have implications for seeding early next season and supplies thereafter.

Supply down but stocks forecast to be healthy this year and next

Latest data from the USDA estimates 2011/12 output at almost 123 million bales, up from 115 million bales in 2010/11 and a record annual output. Taken together with estimated consumption there is expected to be a surplus of 12.8 million bales in 2011/12, the last significant surplus being 12.4 million bales in 2004/05.

Using the same USDA data, the stock/use ratio (a key indicator of the availability of raw material) is estimated at 53%, up from 37% in 2009/10. The latest forecasts from the International Cotton Advisory Committee (ICAC), published early February also suggests the stocks/use ratio will be 53% in 2012/13, which effectively means that the world will effectively have half the world’s supply in store this year and next.

Price outlook

As described there are some bullish factors in the market, namely the drought in Texas, Chinese purchases, recent better than expected economic data and increased speculative activity. Nevertheless the market for cotton, other commodities and indeed other financial markets may have got ahead of themselves after being unduly pessimistic heading into the end of 2011 and it feels that the bullish factors are already known and priced in. Furthermore, the fundamental supply situation remains broadly plentiful going forward into 2012, even accounting for the potential for reduced acreage devoted to planting. Our central forecast for the next three months through to the end of April is for prices to continue to find a floor at around 95c per lb due to Chinese purchases initially before that price support wanes later in the outlook period. Indeed we expect speculative interest to also provide support to prices early in the outlook period but for disappointing economic data and better than expected supply data to weigh on the market towards the end of April. Our central forecast is for US cotton futures to average 97c per lb in February, averaging 99c per lb in March before falling to 95c per lb by the end of April. Looking further ahead we expect the fundamental supply/demand balance to weigh on prices further through the rest of 2012.

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Chart of the week: Baltic Dry Index falls to 25 year lows

Fri, 03 Feb 2012 08:25:57 -0500

Source: Reuters

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Producer price inflation easing but rising commodity prices are a risk to margins

Thu, 02 Feb 2012 15:42:24 -0500

The latest UK manufacturing data from Markit/CIPS suggest the sector started 2012 in good health with output expanding at its fastest rate for eight months. Although output is up the key factor manufacturers will be concerned about is their margins, which have been squeezed recently in the face of stiff competition from domestic and overseas manufacturers and weak pricing power. So, the third straight month of declining input prices will be of additional relief to UK manufacturers. Indeed, January marked the steepest rate of decline in UK input costs since June 2009 with manufacturers reporting lower costs for metals, packaging, plastics and timber in particular.

The recent relief to manufacturers margins is likely to be short-lived however. Commodity prices, in dollar terms fell by 15.8% (14.6% in sterling terms) in the past year, according to the Economist commodity price index. The price declines were led non-food agricultural commodities such as cotton which fell by 33.2% and metals which decreased by 11.8%. However in the past month or so many commodity prices have rebounded as fears over the European debt crisis and concern over end market demand appeared over-done. In dollar terms total commodity prices rose 4.4% in the past month (5% in sterling terms), led by metals which have seen prices rise by 9.7%.

The broad volatility in spot commodity prices rarely impacts manufacturers bottom lines directly. Depending on the size of the business and the degree to which it is exposed to commodity prices manufacturing firms will use a combination of contracts, forward buying and hedges to reduce their exposure to price volatility. Nevertheless the recent increase in commodity prices is likely to present a substantial headwind when contracts come up for renewal later in the first quarter.

The Markit/CIPS data for the UK also revealed that a shortage of certain inputs and shipping problems led to delivery lead times lengthening for the third consecutive month. A shortage of key inputs and materials is likely to be a big problem for a manufacturer looking to complete and order under certain time pressures and may mean the manufacturer has to manage both higher and more volatile input prices. With commodity supply chains becoming increasingly inelastic, small changes in demand can quickly lead to shortages and price increases. Indeed, in the recently published EEF Executive Survey 2012 key commodity shortages were identified by over 80% of manufacturers as the key risk to growth in 2012.

But how can companies seek to manage this risk? The survey reveals that companies are seeking to maintain ever closer relationships with both customers and suppliers, increasing collaboration and forward planning or seeking to reduce their risk further by increasing the number of suppliers.

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