Flostock News #3 Price Waves Explained

                                        

Lehman Wave explains price swings in the Commodity Super Cycle

The prices in the commodity super cycle peaked in 2007, dipped strongly in 2009, recovered and are now going down again for many years, according to researchers of Columbia University and Citigroup. The mysterious temporary price recovery in 2010/2012 cannot be explained very well by conventional economic theory, but it can be understood if you include the so-called Lehman Wave. The Lehman Wave, which was first described  in 2009, can be defined as a global destocking wave that went through the industrial supply chains after credit became scarce in the panicky period after the Lehman Brother bankruptcy (hence the name). Due to the delays in the supply chains, over-eagerness in the speed of destocking and the cumulative effects thereof, the destocking went too far and the industry had to re-stock. Especially for upstream commodity suppliers it resulted in enormous swings in demand, with the deepest point early 2009, a recovery late in 2009 and a second dip in 2010. As a result the commodity supply/demand balance changed from a shortage in 2007 to oversupply early 2009 and changed back to a shortage again mid-2010, causing both the price dip and recovery. Click here for a blog with more information.

China’s Car industry should stop growing

The Chinese car industry has seen double digit growth for a number of years and is now the biggest in the world with some 20 million vehicles output per year. The Chinese car fleet has grown rapidly to some 100 million and will continue to grow until it reaches maturity level, which could be 500 million vehicles (if China adopts the wasteful habits of the west), but hopefully will stop at a more reduced level such as 250 million. For a mature fleet of 250 million cars you need a replacement production capacity of 25 million cars per year, assuming each car is demolished after 10 years. This means that in 2 or 3 years the Chinese production capacity will be big enough. What will happen to the profitability of the car producers, not only in Europe, Japan and USA, but also in China if the Chinese industry does not hit the brakes in time? If you are active in this industry and want a stock & flow model to analyze this looming overcapacity, just give us a call.

Ships behave like Pork

It takes years to build a ship. This is a problem because all shipping companies order new capacity when demand for cargo goes up. When cargo volume goes down as in 2008/2009, the ships that were ordered before continue to come in, creating a huge overcapacity. So the shipbuilding cycle is no different from the well-known Pork cycle. We may expect that when cargo demand will pick up in the future, the ordering of new ships will start too late and there will again be a temporary shortage when the current overcapacity has been filled and new ships have not been built yet. This will create a new rush in shipbuilding, which will result in a new overshoot some years later. A system dynamic model with global trade as input could show how much ships should be built, helping wharfs, suppliers, shipping companies, customers and investors. 

It may seem strange that investors and shipping companies continue to behave like this despite the obvious cycle, but the Pork cycle was first described in the 1920ies, and is still there. In the period 1990 – 2007 global cargo capacity went up much faster than global trade, both well documented and visible. At this moment the price of shipping volume is dropping dramatically and the price to book ratio is below 1. Investment groups like the Dutch Scheeps-CVs are going bankrupt in numbers (article in Dutch). A simple model with global trade as input could show how much shipping capacity will be needed, and although it may not dampen the cycle, it will help the wharfs, suppliers, shipping companies, customers and investors that study it. 

 

Amplitude of Inventory Wave is proportional to Change in Growth, according to Flostock’s Third Law.

If an end market is more volatile, upstream demand will see bigger swings.  The reason is that the chain adapts its inventory to demand, so if demand changes quickly, the inventory needs to change quickly. The cumulative effect of demand and inventory adaptations is what an upstream supplier sees. Flostock’s models do take this volatility and the response of the chain into account, and therefore become more reliable in volatile times, contrary to most competing systems. Sales manager-driven forecasting, no matter at what level of sophistication and supply chain collaboration, cannot do this. Statistical forecasting goes wrong at every peak. The huge forecasting systems used by banks and governments all but crash (Dutch) when markets make a turn.

In a world that is increasingly VUCA (Volatile, Uncertain, Confusing and Ambiguous), stock & flow based forecasting  is the only way. In Flostock News #1 we described the First Law, which says that the Supply Chain is a Tube.  The Second Law, which says that the Amplitude of the Inventory Wave is proportional to the length of the chain, was described in Flostock News #2. The Fourth Law, which says that Capital goods follow the first derivative of underlying demand, will be described in Flostock News #4. If you want to know more, give us a call or send an email to info@flostock.com.

A Unique Concept for Company Evaluation

Flostock recently issued a new brochure about company valuation for mergers and acquisitions.

Download it as PDF here.

more

Register for the Flostock Newsletter via clicking this link or by scanning the following QR code with your phone: