Twocents.blogs.com reports about The Battle for Inventory.
(emphasis mine) [my comment]
January 31, 2008
The Battle for Inventory
Since large-scale shifts in acreage do not appear to be in the offing and USDA projections show continued tightness in stocks for many commodities well into 2009, users of basic commodities may be increasingly forced to enter into a very different kind of "battle" this year, a battle for inventory.
The battle for inventory could reverse deeply held convictions that have been at the heart of world business practices for the better part of a generation. The last comparable shift in attitudes occurred in 1980-81. It came at the end of an era, 1973-1981, when almost any physical asset, from precious metals to art to real estate, had a very strong tendency to appreciate in value. Having a little extra inventory, therefore, came to be viewed as a positive thing by businesses and investors alike. In the grain business, most farmers with a little extra corn or soybeans felt that they could sell on the next bounce, and merchandisers and end users viewed excess inventory on the books as a cushion against supply disruptions or the next wave of buying by the Soviet Union. Many businesses were not fully aware of how expensive this unneeded inventory was because they often did not have the accounting practices (much less software) that gave them hard data on how much inventory they really needed on a week-by-week basis, and they certainly did not fully segregate the cost of borrowing to finance that unneeded inventory.
The Moment of Truth
By 1980, the American public had decided that they too wanted to invest in appreciating "things" like corn, soybeans, pork bellies and precious metals. A summer drought that year caught the attention of this eager public, and spec longs poured into the corn and soybean markets. Open interest surged to record levels in corn, which traded near its all-time highs all the way through the tail end of harvest, even though the drought had long since ended by then and overall supplies, including grain held in government programs, were huge. The higher harvest prices induced a flood of farmer selling all through the fall, and by early December this flood of selling in the cash markets finally outweighed the flood of new spec longs pouring into futures. Margin calls started hitting the spec 'longs' instead of the grain elevator 'shorts,' and the bull market came to a crashing halt. So too did the idea that excess inventory was a valued asset.
Most importantly, this peak in inflationary psychology coincided with a surge in interest rates as the prime rate ticked up to 21.5% in December, 1980 [this year, we hit the peak in deflationary psychology which coincided with the prime rate dropping to 3.25%]. Farmers, merchandisers and end users came to the sudden, collective realization that the world was entering another period of protracted oversupply in grains, a situation that is actually the historic norm in America [In 2009/10, they will come to an altogether different realization]. These events coincided with the growing popularity of the 'just-in-time' inventory management practices that had been honed to near perfection by Japanese car and electronics manufacturers during the 1970s. The combination of oversupply, ultra high interest rates and new business practices quickly turned the idea of owning extra inventory into financial heresy of the highest order. Accountants, bankers and MBAs descended on America's businesses to preach the gospel of wringing every last ounce of unnecessary corn, wheat, cotton, copper or wing nuts out of every conceivable supply 'pipeline.' To a large degree, the gospel of just-in-time inventory control has prevailed right up to the present - or at least into 2007.
The Pendulum Swings Back
In 2008, however, we find ourselves in circumstances that are directly opposite those that prevailed in 1980-81. Users of commodities and manufactured goods now have business models that rely on weekly, or even daily, calculations of their precise inventory needs. The globalization of the past quarter century has made them comfortable with the idea that basic inputs can be bought almost instantly from cheap and liquid markets around the world and then shipped to their loading docks in a matter of days, or even hours. These models have been working very effectively for years for well-managed companies, and the occasional price spikes that have come along the way have been viewed as temporary annoyances that were likely to disappear before the next business cycle rolled around.
But the "annoyances" caused by historic rallies in 2007 and 2008 are not proving to be so temporary. They have chewed deeply into profit margins at some the world's largest food companies and resulted in permanently lost business for some smaller ones. This is causing a broad array of market participants from US farmers to millers, bakers and manufacturers to the governments of China, Russia, India and Pakistan to rethink the just-in-time mentality. A little extra inventory is starting to be seen as a good thing. Instead of bathing a balance sheet in red ink as was the case in the high interest rate environment of 1980, extra inventory in 2008 may actually save the balance sheet by being a hedge against protracted bouts of commodity inflation and supply disruption. Just-in-time is being replaced by just-in-case.
This could mean that farmers, manufacturers and countries will all begin to factor slightly higher levels of inventory into their "business models."
Resourceinsights asks Is just-in-time nearly out of time?.
Sunday, August 13, 2006
Is just-in-time nearly out of time? [It is now]
Civilization, that is, the congregation of people in large settlements we call cities, is thought to owe its origins in part to the invention of agriculture. By growing surpluses of food crops farmers enabled the creation of an urban non-farming class who engaged in all manner of cultural, governmental, and commercial activities. These activities now preoccupy the vast majority of people in advanced economies.
From year to year the new settlements of ancient civilizations ensured their continuity through one very important measure: the storage of surplus food crops, especially grain. This enabled them to withstand a bad harvest or even two or three without facing collapse.
What a supreme irony then that the sine qua non of civilization--maintaining a store of essential materials--should in our time be considered a source of inefficiency and waste to be avoided at all costs. The long tradition of saving for a rainy day (or as we will see, in our case, a drought-stricken decade) has now been rejected in favor of the so-called just-in-time revolution. For those who didn't get the memo, just-in-time inventory management means that everything needed for the manufacture of any good is delivered to the factory just as it is needed or nearly so. Inventory levels are kept at minimal levels which frees up cash for other purposes.
Just-in-time methods have become synonymous with lean, well-managed international corporations. And, they are now the Achilles heel of a global trading system at risk on several fronts.
It is no accident that just-in-time methods came of age in the 1990s and were adopted by nearly every organization big enough to benefit from them. The relative tranquillity of the '90s made fears of any widespread disruption of supply lines fade from memory. With the collapse of the Soviet Union, there were no more superpower confrontations. The ambitions of Saddam Hussein to control a vast portion of the world's oil supply were contained. The sea-lanes were secured by the dominance of the U. S. fleet. Cheap energy meant cheap transportation which encouraged the expansion of trade. And, this allowed the wholesale removal of industries from places of high cost to places where labor and resources were the cheapest. In addition, the bear market in raw materials continued. This lulled purchasing managers into believing that needed materials would be cheaper tomorrow and the day after that and the day after that. So, why keep anything but minimal inventories?
These conditions created fertile ground for just-in-time ideas in almost every corner of the globe and in almost every organization including government and nonprofits. And, under such conditions it was inarguably better to keep inventories lean. As a result spartan inventories soon became a necessity as company after company sought competitive advantage through this type of cost-cutting.
Whether just-in-time inventory is an idea for all time or was merely suited to a unique moment in history is now being tested.
However, the drop in world grain stocks paints a more ominous picture [Yes, this is where the true crisis lies]. Those stocks have declined to about 57 days of supply. The last time grain stocks were this low was in 1972, just before grain prices doubled. And, as more and more grain is converted into fuel rather than food, the situation may worsen. High oil prices encourage such conversion.
Low grain stocks are also partly the result of declining harvests. And, declining harvests are partly due to drought in critical grain growing regions of the world: the U. S. western and Plains states, Canada, southern Africa and much of Europe.
If global warming is the culprit, this problem is not going away. [declining harvests are caused by desertification and the overuse of water resources]
Of more immediate concern is the way just-in-time ideas have filtered into the retail food system. Grocery stores are believed to have no more than a three-day supply of food [Do you see the potential for disaster here?]. That means those who don't grow their own food (which is most of us) will find themselves going hungry within a week of an emergency that shuts down the just-in-time delivery system to stores. What could do that?
Try an avian flu pandemic. [Try a dollar collapse]
And, that brings us to the medical field which has long been applying the minimalist, just-in-time view to its operations. The corporate mentality driving both for-profit and non-profit hospitals has resulted in an attempt to keep capacity to a minimum in order to drive down costs. But, the effect has been to undermine surge capacity, that is, the capacity to treat large numbers of patients from a mass casualty event such as a terrorist attack or a flu pandemic. The issue also applies to vaccines, drugs and medical equipment that might be needed in an emergency.
When it comes to oil, there is a recognition on the part of nearly every major importing nation that just-in-time inventories are not enough [which is why the crisis will not happen in oil but in food staples]. The United States, the European Union and China all have plans for or already have in place large state-run petroleum inventories, normally referred to as strategic petroleum reserves.
Perhaps the ultimate expression of the just-in-time idea is Wal-Mart's so-called warehouse-on-wheels. Only in a cheap oil environment would the idea of motion be added to the idea of warehouse. Wal-Mart tries to keep much of its inventory on the road in trucks to maintain low costs and flexibility. This is the ultimate in just-in-time delivery.
But, those who believe world peak oil production will soon be upon us with its skyrocketing oil prices think that Wal-Mart would quickly crumble under the resulting financial and logistical strain. [When China revalues the yuan in response to soaring food prices, the Wal-Mart's just-in-time delivery system will collapse]
When any resource becomes scarce, the natural tendency of people is to hoard it. That has the effect of sending the price higher which makes people think they should hoard it all the more.
In the coming years we may be faced with such a dynamic in many markets. The most devastating and far-reaching effects could come in the
energy markets [agricultural markets]. Will the just-in-time religion which swept the world in the 1990s survive such a dynamic? [No] Will the new fashion be to plan ahead and make sure we have extra supplies of metals, fuel, medicine and food on hand to run our factories and our civilization when disruptions occur? [Yes]
Such a novel idea, isn't it? Or maybe it's an idea that's as old as civilization itself.
Below is a graph of open interest of major commodities. It shows how, since 1986, commodity users and investors have been willing to substitute paper inventory for physical inventory. In today's world, commodities hold less than a few weeks' supply of physical inventory and rely on futures to hedge price risk. This is a disaster waiting to happen.
My reaction: The 2009/10 food crisis will be a game changer. As food prices double, then triple, countries around the world will see the wisdom of keeping some emergency food stocks on hand.
1) Just-in-time inventory is COMPLETELY DEPENDENT ON A STABLE DOLLAR. If the dollar goes into a freefall, the US futures markets and the entire global just-in-time system will collapse. Do you think it is an accident that China is building up several months supply of commodities? They see what is coming.
2) In December 1980, global inflationary psychology peaked as the prime rate surged to 21.5%. Since then, "the combination of oversupply, ultra high interest rates and new business practices quickly turned the idea of owning extra inventory into financial heresy of the highest order", leading to just-in-time inventory.
3) In January 2009, global deflationary psychology peaked as the prime rate dropped to 3.25%. Now the global just-in-time inventory system faces collapse in the face of record low inventory levels, underproduction of critical commodities, ultra low interest rates, and rising Chinese demand.
Conclusion: The collapse imminent of global just-in-time inventory system is a major
Gold breaking the $1000 barrier definitively is evidence that the end of the dollar is near. The US Dollar index, as seen below, also shows signs of breaking down. Once the dollar enters a freefall, the global just-in-time inventory system will collapse.
The end of just-in-time inventory will be a very bullish development for commodities and commodity related investments, which is why I am starting a fund to invest in Russian agriculture.