Buying Metals? Share the Risk…

Thursday, June 7, 2007 20:25

Manufacturing is full of risk, and in China there are many who have devoted a lot of time writing about those risks (see out posts here, here, and here).

However, on risk that everyone share around the world is that the price of raw materials may go up… and unfortunately, over the last 2 years anyone in the the metals trading, scrap metal, commodity brokering/ investment will attest to this…For those that bought forward of metals like Nickel and Aluminum, the gains were big as the prices have gone up significantly over the last 18 months (and there are big swings that can be seen in that time as well).

For those that are manufacturing though, the concern is often not how to make money from the swing, but how to minimize the effect of the swing. The markets (London Metal Exchange and Shanghai Metals Exchange) can move fast, and pricing move faster (If you thought the price of gas moved fast.. you haven’t met our Aluminum wholesaler).

During our time in China, we have worked on a number of cases whereby the very metals that are seeing 10-20% price moves in a month were the primary component (90% or more) of a product… Construction tools, auto parts, aluminum scooters, metal plates, etc …. and when the prices move 5%, it can add up quick

Example: a ton of aluminum that is now in the 20,550RMB/ ton region (2700USD/ ton) was in the 15400 RMB/ ton region (2250USD/ Ton) 3 years ago. About a 20% increase in raw materials PER TON-

Note: I am using 7.6RMB/ USD. If you were to use 8.28RMB/ USD for trading price 3 years ago, the increase would be 840USD a TON or 45% change

So, you can now see why manufacturers look to minimize their exposure and the impact of such moves,

For many of my clients, or perspective clients, they are already often fully aware of this, however they are often not aware of their options when dealing with Chinese suppliers… and as a result we have had some frustrating conversations to say the least

In an environment where year long pricing contracts in many industries is common, and the power of OEMs can at sometimes be described as omnipresent, many look to achieve the same terms in China as they would in the U.S.

in the case of two projects recently, the entire project depended on the ability of the supplier to guarantee a price for an extended period of time (one was for 6 months.. the other was a YEAR). Now, keeping in mind the fact that China is gobbling up metals at such a fast pace that manhole covers are stolen and sold for scrap, no supplier in China is going to be willing to take that gamble… unless:

1) The buyer is Wal-Mart, GM, or some other firm that will eat up the majority of capacity ….and they really really want the business

2) The buyer puts down a deposit (usually 30%) on the annual expected production

3) The price in the risk of such increases into the initial quotes.

In our case, we were not working on behalf of a firm that had the ability to eat up the majority of capacity, and so.. it came down to one of the last options for both firms. Initial resistance for investment was high, we knew that presenting the idea was going to be difficult. We had already figured out the current price structure for the products and knew what to expect at current pricing. However, when the client pushed back on the 30% down option the supplier raised the prices (significantly) to reflect his perceived risk…

In the end, neither deal was closed as the foreign party was unwilling to bend for the 30%, and they were unwilling to pay the premium price that the suppliers wanted for taking on the risk.

What should have happened, in my humble opinion, is that both foreign buyers should have understood that as the relationship was new, the perceived risk was higher than had there been an established relationship. they should have taken the short term risk on themselves by doing some homework on the pricing, and been willing to accept a floating price for the first 3-6 months until the relationship was established.

Sure, there was a risk of loss… but looking long term, the gains were definitely there, and by rejecting the fact that the supplier needed to consider their own risk, the foreign buyers lost a long term opportunity.

In the case of one client who we have been assisting for 2 years now, there is a lot more give and take, and we have established trading bands whereby prices move only if the SME price goes outside the band… and it works for both sides.

Especially since everyone involved understands that if the raw material price of metals go up in Shanghai, they will eventually go up at the distributor in Oakland, and at the site in Piedmont… for themselves and their competitors.

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