Thursday, October 27, 2011

The Euro crisis and Rubber Prices

Anybody reading world news, especially on the economy, hasn’t seen one day go by without new disturbing headlines about the fate of the Euro, the Euro zone, and the consequences for the world economy.

This has been dubbed the second financial crisis; the first being the bursting of the real estate bubble in the U. S. (As it happens I was a victim of that bust as real estate prices plummeted to a level below the actual value, which came at a time when I was selling my house in Florida. Instead of pocketing a nice profit, I had to make do with just a fraction of that.) Anyway, the second financial crisis, although in part directly connected to the real estate bubble in the U. S., has been brought on by governments in the Euro zone overspending, which led to some countries having more debt than their GDP, e. g. Ireland, Portugal, Spain, Italy, and the most notorious of them all – Greece. Ireland’s banks were heavily involved in U. S. real estate. Some of them had to be bailed out by the government. Portugal and Spain had their own real estate bubble that could only burst as well, as all bubbles eventually will. Italy doesn’t know how to manage money to begin with – how can a country that has had 50 governments in 50 years ever properly administer itself? Greece, with no notable industry besides tourism, an overblown bureaucracy, a non-existent tax collection system, no administration to speak of, and where the public sector comprises 80% of the economy, submitted to the seduction of easy money and loaned money left and right to maintain an opulent life-style, as it would be termed for private individuals.

All countries have in common that their governments issued bonds to finance the big holes that had opened up in their economies - Ireland, Portugal, and Spain for bailing out their banks and Italy, which so far has not needed any help yet, for overspending in the public sector. I don’t want to go into any more detail here. If interested you can always find more in the big international newspapers – both off and online.

Now what does all that have to do with rubber prices? Well, what you read in the papers is that the ‘market’, in other words the ‘speculators’, immediately reacts to any news. Over many years, I have been following this with dismay. It had come to such a point that when there was even the slightest hint of a problem in the Middle East oil prices would jump up within a minute. One could even think that the news when some Middle Eastern potentate so much as broke wind the markets would react. It could be the Middle East, it could be China’s impending cooling of its economy; the reasons are as manifold as there are imaginative financial instruments.

Now for the past 18 months it has been the crisis of the Euro zone. Economists fear that when the rich European nations, mainly Germany and France, bail out their ‘poorer’ co-members, they would overextend themselves and cause the failure of their banks with catastrophic consequences not only for their economies but also for the world economy altogether. Adding fuel to the fire are those private, for profit rating agencies that feel called upon to judge the value of bonds, countries, companies, practically everything. They even downgraded the U. S. debt. The U. S., despite its economic woes, still is the world’s largest economy and without doubt will eventually pull out of its recession and its deep debts, however long it takes. Anybody who thinks that they won’t be able to redeem their treasury bills must live on another planet. So what is that downgrading supposed to mean and to achieve – perhaps maximizing profits for short-sellers? Promptly, the announcement had an instantaneous effect on the markets. The Dow Jones plunged 635 points. Ironically, treasury bills rose the next day – now who can understand that? One shouldn’t forget that those same rating agencies had given toxic real estate derivatives an AAA rating until the whole thing went bust.

Similarly, any news that comes out of Europe regarding the bailout of Greece has an instantaneous effect on the markets. Reading the news about this is like a roller-coaster ride. One day it’s more or less positive, one day is negative, with the negative outweighing the good news. It seems as though journalists thrive on painting bleak pictures.

Initially, all this had virtually no effect on rubber prices but when the Greek problem came up, they eventually took their hit too. In 2010, the strong Chinese economy overshadowed the Euro crisis. China is the largest buyer of natural rubber. Rubber prices remained at an all-time, and somewhat uncomfortable, high. This lasted until April/May of 2011 when Greece’s debt was finally reduced to junk status by the rating agencies. Paired with the fear of a weakening of European and U. S. economies, which would lead to a lowering of Chinese industrial output and reduced purchases of raw materials, this news started the slow but steady decline of rubber prices. This graph aptly illustrates this fact. These prices are for processed crepe rubber on the Malaysian Rubber Exchange; the Cambodian prices follow the exchange.

Month Price/100kg CSK5L

Jan 503.13
Feb 559.70
Mar 539.82
Apr 557.86
May 519.51
Jun 505.83
Jul 485.49
Aug 474.17
Sep 452.31
Oct 427.09

Prices for latex sold in Cambodia to processing plants follow a similar pattern as this graph shows, although there was a short recovery period in June when Euro zone ministers committed to a bailout package for Greece. Prices are $/kg.

Let’s see what this does in dollars and cents for the operators of rubber plantations in Cambodia. 40% of all plantations are smallholders, that is, they range from 5 to 50 ha. Let’s use a 30 ha plantation and an average production of 150 kg of dry latex per ha per month, or 450 kg for 30 ha.

Since February is the so-called wintering period on a plantation, we will start with April of 2011. The owner could record gross revenues for each month until October of this year.

April $ 17,313
May $ 15,255
June $ 17,454
July $ 16,098
August $ 15,606
September $ 15,686
October $ 13,185.

Compared to April the owner had approximately $4,300 less in his pocket in October; this translates into 25%, and that’s a lot of money in anybody’s book. Reason: the news had become extremely volatile in October; some even feared the collapse of the Euro zone. In previous months, the average price levels were helped by intermittent better news, which caused upticks in prices. A major positive decision was reached this week and so far, rubber prices hover a little above their lowest level in 2011. Of course, commodity prices are very high to begin with and an adjustment might be called for, but then markets don’t always react logically.

To those who think this is still a good income in a country like Cambodia I can say they are right but should not forget that those are gross revenues; operating expenses are considerable what with expensive fertilizers, fungicides, manpower, machinery, etc. Additionally, in order to get to this revenue level the owner needs to invest first in land, land preparation, then in seedlings, management, etc. Until trees produce good amounts of latex, the owner has to wait roughly 10 years. Although production usually starts after 6 years, yields are not in the higher range until year 10. So it’s not just sitting back and collecting money.

If you follow a certain reasoning you could say that Greece and the markets not only hold the European governments hostage but the smallholders in Cambodia too, not to mention the huge investment plantations. Greece with its unconscionable policies, and the speculators with their insatiable greed make their actions felt throughout the world. The rubber plantations are but a small part in the overall picture.

It is ironic that a country with a population of roughly 10 million people could get the large European economies (Germany with a population of about 82 million, France with 56 million) into a severe recession, not to mention the reverberations in the rest of the world. It is equally incomprehensible that the markets, say speculators, can determine a government’s policies. Mind you, this is a sector of the economy that does nothing but shuffle papers or hit keys on a computer keyboard and with that produce profits (or losses) for investors. It’s called investment banking. Most of the large banks are engaged in investment banking. They accept huge risks and but when they incur huge losses they all of a sudden become too big to fail and need to be bailed out by the government, in other words, taxpayers’ money. It is an old axiom that only money makes money, consequently if you have no money you cannot invest, but if you have money and you can invest and make a tidy profit, you should also be ready take a loss.

When I went to business school, I learned how to assess the value of a company based on its assets, liabilities, productivity, market position, long-term viability, earnings and earnings potential, etc. Those things have all gone out the window. The dot com bubble showed it, the real estate bubble showed it, and any subsequent bubble will show it as well. There is nothing wrong with trading in stocks, bonds, and such, but when it comes to buying and selling stocks, you don’t even have with borrowed money, a line must be drawn. Just look up the term ‘hedge funds’ and you will get an idea who dominates the financial world and who can ruin many an existence.

If you are interested in following the timeline of the Euro crisis, go to


dropshot said...

Good write up!! The total revenues over a 7 month period are approx $110K in the example above. If extrapolated over a 10 month period, you get ~$132K. Is this a reasonable assumption of estimated annual revenues for a 30 hectare plantation?

Also, any idea what would be the direct costs (labor, materials, chemicals and other direct expenses) to produce this quantity of rubber? 30 to 40% of revenues??

In addition to direct costs you also have depreciation, capital expenses, finance charges (if any) and other non direct expenses.

KJE said...

You obviously know what you are talking about; you are right about the revenues and direct costs. Of course, as prices decrease the ratio changes.
As for depreciation, currently there is none; in effect, we are seeing an appreciation as both land prices and good will values of rubber plantations have been rising after an 18-month standstill; and this despite a sharp decrease in rubber prices; current levels are in the $350-$360/kg range.

KJE said...

That should have been $350-$360/100kg range.

dropshot said...

That was just an educated guess on my part.

I am thinking a good way to hedge rubber prices would be to have other crops such as soybeans, pepper or palm oil trees in separate areas on the same land. Wonder what the correlation is of the prices of these commodities and whether they can be cultivated together?

KJE said...

Do you also have a good power serve?
The best thing to do in commodities market is to be also engaged in some other business. Soybeans, pepper, and palm oil are good crops but you would need a separate tract of land for each. While you can plant soybeans on maturing rubber plantations, but as soon as the crowns are closed it is over. Pepper is a pretty stable product but you need a larger acreage to make it worthwhile; the same goes for palm oil. Look at the size of the Mong Rethy plantation along road no 4. And prices are even more sensitive than rubber.
Cambodian farmers are very much into cassava. It is cheaper to grow but prices are pretty low too.
Rice is a very profitable business unless you encounter a natural disaster like this year, and your crop is destroyed. If you are good at it you can get two crops a year and still survive. So it might still be worth your while.