Friday, June 1, 2012

The Euro Crisis and Its Impact on Rubber Prices – Round II

It is apparent that European politicians are out of their depths dealing with this crisis. Six months ago they agreed on a parachute to bail out Greece from its irresponsible spending policies. That sort of softened the blow on the world markets and commodity prices after a sharp decline across the board began to rise gradually. Rubber prices reached $4,000/mt for TSR5L and $3,750/mt for TSR10 again at the beginning of April. (Cambodia sells their high-quality crepe rubber at a roughly 15% discount, which is roughly the same as the TSR10 price. It uses the TSR10 category as its benchmark.) While I viewed $3,000/mt for the TSR5L as a sustainable and economically sound level, I needed to revise this due to increasing labor and general maintenance costs. I now hold that the $4,000/mt is the right and acceptable price for all concerned – the farmer, the processing plant, and the manufacturing sector.

That spring did not last long for rubber prices. Obviously, some spring fever had also infected the Greek politicians, especially the leftist parties there, as they stalled in forming a government after the election which sent the markets jittering and promptly led to a downward trending of rubber prices, among others. Germans who bear the largest share for that parachute want strict adherence to austerity, which the Greeks find too hard to swallow, but is a prerequisite for further money injections into the Greek economy. Other countries want a loosening of the purse strings so investments can kick-start ailing economies in the Euro-zone. But let’s not get into too many details here. The whole thing is a quagmire. Interested readers can find ample information in all large newspapers. Only one thing is clear – instead of acting decisively European politicians are dragging their heels, thereby confounding the problem without regard for the consequences on markets and with the all-important issue of creating or at least maintaining jobs. 

The uncertain situation in Europe right now has in reality no immediate effect on any of the sectors of the rubber industry. Supply is the same and demand is the same, at least more or less. Worries about the future of the Euro do not mean buyers will buy less rubber right now. Only the ones speculating in rubber, and this is a small part, will hold off buying, hoping for a further decline in prices so they can stock up at low prices just to sell it off at a good profit once prices have recovered. But generally, the manufacturing industry will need just as much supply now as it will in June or July. Just-in-time management will prevent that sector from overstocking. They conclude term fixed price purchase contracts to offset wild fluctuations. The culprits are again the speculators – the one sector of the economy that has become the scourge of modern-day business. Impotent politicians and unconscionable speculators make for a deadly combination.

Markets will always rebound. It is just a matter of time. How long will it take? My guess is another 3 months or so. You have the new elections in Greece in June and you have the referendum in Ireland on the fiscal pact, which will both greatly influence how the rest of Europe will respond. No European government has promulgated a clear program about what they will do in any eventuality. But eventually they will have to do something. They can’t keep on muddling through forever. But I don’t think we have seen the bottom of rubber prices yet. Saying how low it will go would be like reading tea leaves. Who can predict anything these days? Professional analysts are highly paid but seldom get it right either. The Chinese economy is slowing down as well, which now prompted the Chinese government to open the money spigots to again make available money for mostly infrastructure projects. But even that news did not have any effect on prices. The worries about Spain overshadowed everything this weekend, sending all major markets into a downward spiral.

How does it affect the farmer in Cambodia then?  Dry latex sells for $2.12/kg right now. Production cost is anywhere from $1.00/kg to $2.00/kg. So it is hard to say where the break-even line is for whom. Larger plantations have higher operating costs; some plantations have lower amortization depending on how much they paid for the land, perhaps they inherited it, etc., etc. Let’s just use $1.50/kg production cost on average.  Based on past price movements the price would have to fall to $2,700/mt for TSR5L or $2,040/kg for TSR10. The last time we had that was in October of 2008. Six months ago the lowest prices we saw were on Nov. 29, 2011. TSR5L was noted at $3,393/kg and TSR10 at $3,196/kg. In comparison the prices on June 01, 2012, the date of this article, were $3,550/kg for TSR5L and $3,118/kg for TSR10.

All this leaves owner’s benefits or a general manager out of the equation. Labor costs were calculated for tapping staff and technical supervisors only. Larger plantations need shift foremen, section supervisors, etc., and a general manager. Production cost will rise in proportion to the size of the plantation. But in any event we are some way off from red ink.

One interesting aspect of the near future that might interest potential investors is the fact that many maturing plantations will soon produce a yield. Many private plantations were started with the sole purpose of selling it at some time during the maturing stage. Demand has been there and many a young plantation has changed hands. I am just wondering what the owners will do if they can’t sell theirs. They will have to look into managing it themselves, that is, hire staff, etc. My guess is that quite a few don’t want to go to those lengths. Most private owners are absentee owners and have little inclination of going into operating a plantation. I would think the current high prices will start to drop to more realistic levels. The latest offers I have seen for a 6-year-old plantation are in the range of $20,000/ha. That seems over the top when you consider that the investment over the 6 years was about $7,500 to $10,000/ha, again depending on the value of the land. So there is much room for negotiation. But then, Cambodian minds work differently. Some just don’t want to make any concessions. But even at high prices and factoring in amortization over 20 years purchasing a plantation still makes good economic sense. One must not forget that after the trees stop producing they will be cut down and the logs sold for use in mostly furniture. The owner still has the land after that time and can start a new plantation or plant a different crop. Most likely the value of the land will have appreciated considerably too.

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