The economic conditions across the globe have driven the value of the US dollar to some of the highest levels we've seen in years as compared to virtually all other major currencies in Europe, Asia, and Latin America. It's well known that this new-found strength in the dollar has a negative impact on US exports. This week, however, Proctor & Gamble (NYSE: PG) provided an impromptu lesson on the full impact of foreign exchange on global corporations. For anyone interested in the details, their Q4 2014 Earnings Call Transcript is a must-read.
What is important to understand is that the exchange rate between the US and the Euro only impacts one aspect of a global business. Right now, the impact on the bottom line is a negative one, for sure, since the translation back into US dollars is not favorable on the balance sheet, but across Europe as a whole, the problem gets significantly worse.
Goods or product components that are exported to Europe, for instance, are in turn exported to other countries on the continent that are not necessarily in the Eurozone. This leads to yet another foreign exchange transaction that, depending on the value of that currency versus the Euro, may translate into another negative bottom line impact. This is especially true if the destination is Russia, Ukraine, or one of the other Eastern European nations with similarly depressed currencies.
Using P&G as the example, they experienced a negative foreign exchange impact to the tune of $1.4 Billion after tax. Six currencies contributed to 71% of that total, and they represent countries from around the globe: Venezuela, Russia, Japan, Ukraine, Argentina, and Switzerland. It's common for global companies to import components - P&G used plastic bottles as their example - into a destination hub for subsequent packaging. In the case of the bottles, you're looking at a Euro to Rubles conversion that is a bottom line negative impact, followed by a Euro to Dollar conversion on the balance sheet that is yet another bottom line negative impact. The more components imported from around the globe, the greater the impact, especially when the final destination is a country with a very low-valued currency.
Between the actions taken by the ECB to introduce Quantitative Easing, the actions taken by the Swiss recently, and the impact of geopolitical tensions between Russia, Ukraine, and the west, global companies will face this FX headwind through 2015 and likely beyond. While Proctor & Gamble did a fantastic job of detailing the impact in their conference call last week, the lesson they provided applies to all companies that have a global reach.
There is no evidence that the US Dollar will weaken in 2015. In fact, there's suggestion now that it may test its all-time strength against the Euro before the year is out. We can expect this to put a significant amount of financial pressure on companies with a large exposure to Europe. Be sure to factor this into your analysis of companies when planning a long-term trade or an investment. It's a factor with which we have not had to deal throughout the run of this bull market. Now that it's here, at least for the next year or so, we need to factor it into our thinking.
Showing posts with label dollar. Show all posts
Showing posts with label dollar. Show all posts
Sunday, February 01, 2015
Sunday, January 18, 2015
The Significance of Copper's Current Price Moves
As if the plunging prices of oil weren't enough to worry about, pundits are now citing a "crash" in copper prices as further confirmation that the health of the global economy is deteriorating rapidly. I've heard some question whether copper is signalling a global recession, or if it's signalling significant weakness in the US and China at the very least. Well, before we start forecasting impending doom, let's take a step back and look at this "crash" from a broader perspective. Here's the weekly chart of copper prices from 1/3/2000 to the present.
As you can see from the chart, Copper has a tendency to follow global economic health. Whether or not we can call it a leading indicator is somewhat doubtful, though, and in my view it would be a stretch of the imagination. The two shaded green areas on that chart show the extreme market crashes that followed the September 11 attacks in 2001 and the financial crisis in 2008.
Nobody will argue that any market indicator could have foreseen the market crash following a major terrorist attack, so there were no leading indicators that would have foreshadowed the post 9/11 crash. Yet, as you can see from this chart, Copper started heading down following a peak over a year earlier. Conclusion: there was no correlation between the two.
Look at the 2008 scenerio. Again, Copper was trading in a very gradual incline until the financial crisis hit, and it then followed global markets down, just like every other commodity. The key is, it followed, but it didn't lead. Benefiting from a plunging dollar and a surge in economic growth in China, Copper surged from mid-2008 until the Commodity Bubble burst in 2011.
The 2011 burst of that bubble was inevitable, since it was not possible for China to continue the level of growth it had sustained for the prior three years. As China slowed, so did the demand for copper, and the prices gradually declined. You can see from the chart, in fact, that the price managed to find some support around the 61.8% Fibonacci Retracement line, until it finally penetrated that line for good in November, 2014.
In the past two months, we've seen a significant drop in price back to the 50% Fibonacci line, but before we panic, let's stop and thing about what drives the price of copper. There are three factors:
1. Demand, primarily in China. Well, that demand appears to be holding steady. It's not growing, but neither is it dropping at any significant rate. In fact, some of the early guidance we're hearing out of companies with exposure to China seem to indicate modest growth there for 2015, so I don't think weakening demand is driving the price down.
2. Supply. Well, it's definitely possible that there's an increase in supply. There was speculation last week coming out of Morgan Stanley's commodities analysts that a drop in oil prices would encourage mining companies to increase their production of commodities such as copper. It's possible, but I doubt that's what we're seeing in the current price drop.
3. Strength of the US Dollar. Here, folks, we have the winner. The price of commodities, including copper, carries an inverse relationship to the value of the dollar. As the dollar increases, commodities prices fall. What we've had in the last few months is a very sharp increase in the value of the US Dollar, culminating with Friday's 10-year high against the Euro. This factor alone fully accounts for the sharp drop in copper prices last week.
Is the global economy weakening? I'd certainly say Europe's is weakening, but China appears to be holding steady, as is the economy in the US. Growth is weaker than I'd like it to be, but there's nothing out there indicating an imminent recession. So when we look at the plunging prices of commodities in general and copper in particular, let's not forget that it's more than a supply and demand equation. Factor in the value of the dollar and we have a perfectly good explanation for the behavior without resorting to a doom and gloom economic forecast.
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| $COPPER EOD Price |
Nobody will argue that any market indicator could have foreseen the market crash following a major terrorist attack, so there were no leading indicators that would have foreshadowed the post 9/11 crash. Yet, as you can see from this chart, Copper started heading down following a peak over a year earlier. Conclusion: there was no correlation between the two.
Look at the 2008 scenerio. Again, Copper was trading in a very gradual incline until the financial crisis hit, and it then followed global markets down, just like every other commodity. The key is, it followed, but it didn't lead. Benefiting from a plunging dollar and a surge in economic growth in China, Copper surged from mid-2008 until the Commodity Bubble burst in 2011.
The 2011 burst of that bubble was inevitable, since it was not possible for China to continue the level of growth it had sustained for the prior three years. As China slowed, so did the demand for copper, and the prices gradually declined. You can see from the chart, in fact, that the price managed to find some support around the 61.8% Fibonacci Retracement line, until it finally penetrated that line for good in November, 2014.
In the past two months, we've seen a significant drop in price back to the 50% Fibonacci line, but before we panic, let's stop and thing about what drives the price of copper. There are three factors:
1. Demand, primarily in China. Well, that demand appears to be holding steady. It's not growing, but neither is it dropping at any significant rate. In fact, some of the early guidance we're hearing out of companies with exposure to China seem to indicate modest growth there for 2015, so I don't think weakening demand is driving the price down.
2. Supply. Well, it's definitely possible that there's an increase in supply. There was speculation last week coming out of Morgan Stanley's commodities analysts that a drop in oil prices would encourage mining companies to increase their production of commodities such as copper. It's possible, but I doubt that's what we're seeing in the current price drop.
3. Strength of the US Dollar. Here, folks, we have the winner. The price of commodities, including copper, carries an inverse relationship to the value of the dollar. As the dollar increases, commodities prices fall. What we've had in the last few months is a very sharp increase in the value of the US Dollar, culminating with Friday's 10-year high against the Euro. This factor alone fully accounts for the sharp drop in copper prices last week.
Is the global economy weakening? I'd certainly say Europe's is weakening, but China appears to be holding steady, as is the economy in the US. Growth is weaker than I'd like it to be, but there's nothing out there indicating an imminent recession. So when we look at the plunging prices of commodities in general and copper in particular, let's not forget that it's more than a supply and demand equation. Factor in the value of the dollar and we have a perfectly good explanation for the behavior without resorting to a doom and gloom economic forecast.
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