Why You Shouldn't Predict Firm Metals Pricing for the Year Ahead

“Our job as responsible, sustainable, competitive suppliers is to intelligently manage risk.”

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This is the time of year when purchasing agents and buyers try to get us to agree to and commit to long-term, fixed pricing for parts, which are largely produced from various metals. Here are four reasons why you should not plan on an accurate pricing forecast for metals this year:

  • Business cycle
  • Bias toward growth
  • Volatility
  • No knowledge of the determinants of demand
     

Business Cycle 

The business cycle is best visualized as a sine wave with phases like AC current. At the time that I am writing this, the business cycle is in a softening phase, above the zero line, but coming off of peaks in demand and pricing in the markets we serve. It is a downward slope. In this phase, a savvy organization would typically be working to set budget reductions, avoid long-term purchase commitments, reduce inventory, cross-train employees and evaluate vendors for strength. Nothing in the business cycle at this time justifies firming up pricing in the face of falling demand.

Bias Toward Growth 
Everyone expects the prices of things to grow, especially for commodity raw materials. And if that always happened, we’d probably be paying a million dollars for breakfast, let alone the raw materials we buy for our shops. But prices do not trend inexorably upwards. Using the Steel Benchmark Chart (above) for hot-rolled band as a proxy for raw materials prices globally, we can see that yes, U.S. hot-rolled band prices are just over double what they were in the first half of year 2000. However, the predominant trend since midyear 2011 has been downward from more than $950/$975 per ton in July 2011, to $730 per ton last month. While the overall trend has been downward since mid-year 2011, a look at the chart shows that there have been five (we’re in what appears to be the sixth) upturns. Whether or not the prices tend to increase really depends on the starting point when you look at historical data.

Volatility
Volatility is another aspect that can greatly influence price, and about which we have no clue. Just doing a “back of the envelope” calculation from the data on the Steel Benchmark Chart, the price differential (regardless of sign) for any calendar year ranges from a low of about 4.5 percent in 2012, to a high of 100 percent in 2008. For 12 of the 13 years shown, the percent of change was in the double digits range, and for 7 of those years, that double digit change was between 21 and 100 percent.

Determinants of Demand
We really have no knowledge of the determinants of demand and neither do our customers. Yet the supply and price are determined by demand. Demand is not just local to us here in North America. Increasingly, prices and supply are determined by global demand. What is your forecast for demand in China? In India? In Germany? In the U.S.? A “safe guess” would be that demand will follow GDP growth. For the U.S. that would have been under 4 percent for most of the last decade. How well does that play out against the changes we have seen in pricing over that same term? 

According to World Bank, U.S. GDP growth for 2013 was estimated at 1.6 percent; China’s was estimated to be 7.5 percent and world GDP was estimated to increase 2.9 percent. How do those numbers compare with the price changes shown on the Steel Benchmark Chart?

Customers seek pricing assurances in order to eliminate their risk. By just shoving the risk onto their suppliers, they do not eliminate the risk; they just change the ownership.

Conceding fixed prices for the raw material portion of your parts price is a fool’s errand based on the factors explained here. Our job as responsible, sustainable, competitive suppliers is to intelligently manage risk. Locking in future prices without any degree of control of any of the factors can only turn out badly.