Rapid rally strains supply, but troubles are likely to be short lived
By Anne Millen Porter -- Purchasing, 2/5/2004 2:00:00 AM
The view from manufacturing buyers participating in PURCHASING's monthly Business Survey is that product demand continues to ramp up—in many cases very quickly. While plenty of buyers say their company's end-markets are improving rather slowly; only a handful claim their companies are not participating in the recovery at all.
That's the good news. The bad news is that no one seems to have anticipated the speed at which the manufacturing economy would accelerate, so there's a whole lot of gear grinding occurring. PURCHASING's diffusion index tracking materials inventory strategy among buyers shot up to 42.6 in January—the highest it has ever been—representing a 15-point increase since August (see first chart). In an economy where inventory has long been verboten, the fact that 26% of buyers now admit to active stockpiling speaks volumes about how lean industrial supply lines have grown over the past 18 months. It suggests buyers are feeling panicky about their abilities to keep production lines supplied consistently and also reflects the fact that buyers' inflation expectations are rising sharply in some commodity segments.
Indexes tracking buyers' perceptions of supply tightness at both the producer and distributor levels also reached record highs in January (see third chart). The materials manager for a Wisconsin-based electronics manufacturer observes that, due to inventory reductions, manufacturers are "pushing leadtimes out, in some cases allocating materials." Likewise, an Illinois-based purchasing manager says, "Suppliers are not holding as much stock and manufacturers are showing longer leadtimes, due in part, I believe, to reduced personnel."
Metals and electronics segments are showing the greatest ill effects, according to buyers. (Plastic parts also receive several mentions on the supply headaches list; conspicuously missing from the list are plastic resins, chemicals, and anything paper based.)
Looking ahead, there's no sign that demand for industrial commodities is going to slack off any time soon. PURCHASING's Forward Demand Index, which tracks the overall trend in buyers' 90-day purchase plans, went to 78.9 in January with 69% of buyers saying they will increase order rates for materials and components (see second chart). The Forward Demand Index for electronics buyers hit 85.5 in January with 78% planning purchase-volume increases. For metals buyers, the Forward Demand Index went to 82.8 with 75% planning to increase order volumes in the coming three months.
This set of conditions—unexpectedly fast demand growth, perceptions of tightening supplies, rising backlogs, strong forward-looking demand, a sudden increase in stockpiling activity, plus persistently high energy, freight, scrap metals and other crude input costs—creates a near-perfect environment for commodity-price increases to succeed over the coming several months.
Indeed, PURCHASING's diffusion index tracking prices paid for materials compared to a month ago rose to 68.6 in January with 46% of buyers saying they have succumbed to paying higher prices for some materials. That forebodes more monthly increases in PURCHASING's Industrial Supplies Price Index (1992= 100), which rose nearly 20% in 2003, mostly in the latter half of the year.
Anecdotal evidence from buyers places some of January's upward price action in electronics, but most of it in the metals arena. In December 2003 alone, Purchasing's Nonferrous Metals Price Index (1/'94=100) surged 25% with no end to the trend in sight as metals demand is perceived to be increasing and supplies tightening worldwide.
PURCHASING's Steel Price Index (1/'94 =100) gained only 2% in December, but the early estimate for January has it rising some 10%—and that doesn't include producers' proposed scrap surcharges, which are ranging anywhere from $15-40/ton (see story on page 14).
Analysis from metals market observers suggests that a large part of the recent demand surge for both ferrous and nonferrous metals is coming, on the global stage, from China and, on the U.S. domestic stage, from service centers ordering heavily to rebuild inventories both as a hedge against future price inflation and to meet more gradually expanding demand from end customers. While demand growth in China for raw metal making materials remains a considerable supply risk for buyers in the U.S., it's likely that domestic demand for metals will settle into a slower growth trend once service-center restocking activity runs its course.
There's other evidence to suggest that recent tautness in commodities markets may sort itself out in just a few months time. Physical production capacity is still excessive across most commodity manufacturing sectors in the U.S. In December 2003, capacity utilization for the U.S. manufacturing sector was 10 points below the peak seen in 1994-95, according to data from the Federal Reserve Board. Capacity utilization among primary metals processors was still 16 points below its last peak while the average factory-operating rate for U.S. semiconductor manufacturers stood 13 points below the last peak.
PURCHASING's Leadtime Index (1992=100), which tracks national average delivery speeds for more than 150 common industrial commodities, plummeted 39 points in January after jumping a stunning 36 points in December. The increase was due to widespread spot shortages in electronics and hydrocarbon-based chemicals. Meantime, January's decline in the overall Leadtime Index reflected shorter average leadtimes across every major commodity category tracked by PURCHASING—including steel and nonferrous metals.
Such volatility in leadtimes is typical during business cycle transitions and suggests that raw materials processors are merely struggling to adjust production schedules and product mixes to meet shifting demand patterns and to keep up with distributor restocking activity rather than purposely holding back production to prop up prices. A close look at PURCHASING's source data for leadtimes shows that December's big increase in the Leadtime Index reflected extraordinarily long leadtimes reported by a small number of buyers across a large number of commodities. From a price perspective, the data would have been more worrisome had it shown a more gradual lengthening of leadtimes affecting larger numbers of buyers.
In the longer run for 2004, a little short-term pricing pain may prove to be a good thing for buyers as improved profitability will inspire suppliers to get out of defense mode, start adding work shifts, rehiring workers, re-firing idled physical production capacity, and competing for market share once again.
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