Should Business Leaders Feel Threatened By The Commodities Markets?
The commodities markets are those which trade standardised and internationally recognise resources such as oil, gold, copper, cotton and so on. The commodities markets have been actively featured in news during the past 4 years, intially in the financial media but now crossing over into mainstream headlines. An example of a mainstream news item would be ‘Gold breaks through $1700 to set new price record”.
Commodities markets have been shooting upwards for 3 major reasons. The first is demand side – emerging economics such as the BRIC nations (Brazil, Russia, India & China) as well as other emerging economies (Malaysia, Argentina, UAE) are demanding raw materials for building & construction to fuel their massive expansion over the past decade. The second factor is the supply side – OPEC have been reluctant to increase oil production, and the mining of gold and other precious metals has not increased with demand. The third factor is speculation in the commodities markets, which has mostly involved investors taking long positions, with record levels of funds surging into ETFs and ETCs and other trusts used to purchase gold on the market, further pushing prices up. (If you don’t understand how people are investing in commodities then there are many web guides to bring you up to speed).
Business leaders have seen their margins and pricing models destroyed as a result. Nestle, Mars and Kraft have responded by increasing prices or quietly decreasing the size of their products (Mars Bar Shrinks), but other companies have been unable, or unwilling to pass prices to customers, such as restaurants who were already seeing drops in customers due to changing propensity to spend during the recession.
This doublewhammy in some cases has lead leaders to become fearful of the commodity markets. This has really brought risk management to the fore. Effective risk management can involve taking long positions in index linked securities in order to generate profits if inflation persists – which will partially or completely offset against losses made through higher costs. Leaders should be very wary of the inflationary environment, and place more reliance on their risk management teams to hedge bets on future price moves. Hedging instruments don’t have an expected positive return, they can merely fix margins ‘as they currently are’, (the counterparty would never enter into a contract that was unfavourable for them), so CFOs should keep a close eye on the commodities markets and a give a close ear to their risk management team in order to possibly dodge further moves ahead.