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A Word of Warning About Commodities


Commodities appear more attractive in rough times than in good times. But remember that booming commodities don't reflect their fundamentals alone.


Here are some quotations from that release:

  • "Global supply of titanium is forecast to increase by 20% in 2010 to around 150,000t following a break in the strong growth cycle from 2005 to 2008 when titanium sponge production increased from 104,000t to 176,000t. The growth from 2005, which saw large volumes of new and rehabilitated sponge production come on stream, was partly driven by a surge in demand from the aerospace sector, but also by growing demand for titanium in chemical plant in China. Chinese output of titanium sponge increased fivefold between 2005 and 2008."

  • "In late 2008, the global economic slowdown and delays in the production of high-titanium content aircraft such as the A380 and B787 caused a sharp decline in titanium demand. At the same time, new sponge plants in the USA and Japan, initiated in the earlier boom years, were coming on stream. In both 2009 and 2010, titanium sponge capacity was surplus to demand and producers delayed further expansions, idled plants and (in China) closed smaller uneconomic plants. In 2010, China has been the main engine for growth and production in that country is again growing strongly with several new large-scale sponge plants under construction."

  • "The easing of world supply of titanium sponge has resulted in sponge prices dropping steadily since 2006 and the market is likely to be overhung with surplus sponge capacity until at least 2012 or 2013."

  • "In 2009, production of titanium sponge was confined to six countries, in order of output, China, Japan, Russia, Kazakhstan, USA and Ukraine. Many of the larger sponge producers have downstream operations producing titanium ingot and mill products, but others have played an important role as merchant supplies of sponge. In 2010, UTMK in Kazakhstan, one of the leading merchant suppliers of sponge, started melting ingot on a trial basis and has entered into an agreement with Posco to set up a titanium slab plant in eastern Kazakhstan. This could have a significant impact on the dynamics of global sponge supply."

  • "There are now 18 companies producing titanium sponge, of which nine are in China, compared with just two plants a decade ago. Many companies have announced further expansion plans, although some are now on hold. If all expansions come on stream capacity could reach 400,000tpy by 2015. The four new projects in China, together with expansions in Japan and Russia, could add 85,000tpy to the total."

  • "In 2010, titanium ingot melting capacity is nominally 340,000t, 85% of which is located in Russia, USA, Japan and China. Melting capacity is at least twice that of sponge output, due in part to the practice of double and triple melting, and in part to the use of scrap in the melt feedstock. The USA dominates the production of mill products for the aerospace industry while producers in Japan and China focus on industrial and consumer applications for titanium."

  • "The global market for titanium mill products in 2009 was about 100kt compared with 130kt in 2008. On a global basis, demand for mill products is divided between aerospace (39%), industrial (48%) and consumer (13%) uses, but there are significant regional variations. In the USA the aerospace industry accounts for more than 70% of demand while in China industrial applications dominate. The rapid growth of industrial markets for titanium in China has shifted the balance away from aerospace, but demand for the higher grades of sponge and ingot is still heavily influenced by the cyclical nature of the aerospace industry."

  • "Demand is forecast to grow at 6%py to 2015, resulting in a market for 140,000t of mill products requiring up to 200,000t of sponge. Industrial markets outside the USA and North America will grow at about 9%py and the commercial aerospace market in North America and Europe will grow at around 8%py, albeit from a low base in 2009, provided that the delayed development of the A380, B787 and A350 gathers momentum and the build rates of the B737 rise. The growth in demand from the aerospace sector will come partly from increased aircraft production, but the main driver is the increased buy-in weight of titanium per aircraft. The greater use of composites, more compatible with titanium than aluminium, has resulted in significant increases in the use of titanium in landing gear, ducting, wing carry through structures and weight-critical forgings."

  • "The main industrial applications for titanium are in chemical/petrochemical plant and in heat exchangers; this sector has exhibited very strong growth over the last five years, almost entirely due to the rapid expansion in construction of chemical and power plants in China."

  • "The market for sponge, unwrought metal and mill products is characterized by long-term supply agreements between major producers and consumers, without the involvement of traders. However, the shortage of sponge in 2006 led to more activity on the spot market and prices for sponge, which had historically hovered around US$7/kg, rose to US$30 by the end of that year. As more sponge capacity came on stream the market started to weaken and by 2010 sponge prices were generally below US$10/kg. Prices of ingot and mill products were also well below the peaks reached in 2006/7. Scrap prices, on the other hand, strengthened in 2010 as supplies had dwindled in 2009 as manufacturing declined. Prices for sponge are not likely to move significantly above US10/kg until 2014 when the surplus capacity should be absorbed."

My comments: Supply trends are up over the long term -- despite a notable hiccup or two -- and those trends are especially worrisome at the top of the food chain: titanium sponge, which is the highest margin space but also subject to wild and unpredictable demand trends. Not unexpectedly, China is a looming and increasing factor (Russia and surrounding "stans" have already been there to dump product whenever they feel like it) -- just like that country seems to be in everything else. Demand for sponge appears robust at the moment but that demand is highly leveraged on aerospace and commercial aircraft. We know about the problems with the Boeing 787 and associated delays. We might be wondering about the political shift rightward in the new Congress and its effect on defense expenditures indirectly related to titanium. More companies, in an increasing number of countries, are getting involved in production, and all of them are interested in the "big enchilada": sponge. Aside from aerospace and defense, there are interesting and important applications in the petrochemicals sector.

Another report that caught my eye came from the Inspector General's Office -- perhaps better thought of as a set of recommendations than as a report as such.

This document, ominously dated October 29, 2009 (the 80th anniversary of The Great Stock Market Crash of October 1929) essentially observes the effect of US Department of Defense orders on titanium prices and suggests the importance of locking in long-term supplies based on index-driven trends so as to ameliorate price spikes. In checking with the Inspector General's Office, I've learned that the document is alive and well in their memory banks and has been appropriately circulated and generally well-received.

As for official implementation, that seems to be an area of question marks, and one of the things you will observe in reading this report, if you do, is that there is a language, tone, and culture all to its own in the world of government and procurement -- something I discovered on the Grace Commission so long ago I refuse to divulge the time frame. But that's important with titanium, because much of the business is concentrated in the defense/military sector.

But I can tell you this: After reading these documents, there was nothing related to sex on my mind and, if I wasn't fully informed about titanium, I was certainly experiencing no bubble-oriented euphoria, either.

Finally, my last investigation was a look at some stock charts and graphs, especially for Titanium Metals Corporation. They are interesting and I've decided not to share my conclusions about that. I will point to some recent price and trading activity worth noting if this company/industry is of interest to you. And I further suggest some in-depth probing regarding insiders, their "chains of ownership" (both personally and via business entities), interlocking directorates and officerships, background history, and recent filings.

I found the this report quite informative in this regard -- especially in the "history repeats itself" department -- but reach out, as there are many places to look around, and the Web is a bottomless reservoir if you successfully fight "the rut."

Additional Laughs

There's another report I discovered that gave me a good laugh but not much otherwise. It began with the sagacious observation that, concerning titanium, "excess capacity remains a barrier to entry," which -- much like Larry the Liquidator's "Show me a company with a rising share in a declining market, and I'll show you the last buggy whip manufacturer" -- conveyed "this industry sucks," but in a much less entertaining way.

Obviously, excess capacity is a barrier of entry. It means there's more of something, and the capability to produce even more on top of that, than the world wants. But "barrier of entry" makes it sound like there's something in the way preventing interested parties from getting involved, when in fact "excess capacity" reflects the fact that the industry would have been better off if there had been something to keep competitors out once upon a time when demand was more consistently keeping pace with supply. The net benefit, however, in such less exciting situations, is to the end user in the general phenomenon of supply overhang keeping a ceiling on costs and prices.

Navigate Your Own Research Path

So there you have it, and I hope I've set you down a path to investigate the topics of commodities, the circumstances surrounding shifts from financial to hard assets, and whatever micro industries and enterprises you may find appealing, informative, and profitable. As the French say when they're going biking -- today on bicycles that sometimes contain liberal doses of titanium -- bonne route!

No positions in stocks mentioned.

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