GE warns higher rare earth prices may impact pricing for lighting products

First Seagate warned that higher rare earth prices are squeezing margins on hard disks. Now, General Electric (GE) has added its own warnings about the soaring prices of rare earth elements (REEs).

In a briefing paper written to explain the situation, GE warns:

“We will do our best to manage these costs where we can, but rises on a similar scale to those seen in recent months will mean further significant price adjustments may be unavoidable.”

The brief paper provides a very general summary of the current rare earth market and describes GE’s current attempts to reduce the impact of high rare earth prices. I now strongly suspect that more and more industrial companies and manufacturers will flag rare earth prices as a potential and/or growing issue. Moreover, these warnings will keep rare earth prices in the foreground of the market’s “thinking” and potentially keep pushing rare earth stocks higher.

Disclosure: author is long several rare earth stocks, including MCP. Also long GE

Seagate warns that its margins are being hit by a “bubble” in rare earth prices

Hard disk manufacturer Seagate Technology reported earnings last night (July 20) and indicated that margins are getting hit by the rising prices of rare earths. Rare earth prices have risen particularly fast in the last 60 days. From the Seeking Alpha transcript of the earnings conference call:

“We do, however, expect a positive margin impact of a more stable pricing environment to be offset by the following factors: the costs of many upstream materials, especially rare earth elements, which have increased significantly. These costs are expected to adversely impact gross margins by at least 200 basis points…”

Seagate has been unable to offset these costs, but over the long-term believes there are no supply problems:

“In regards to the increasing cost of upstream materials, Seagate has historically been able to absorb these cost increases and insulate our customers. However, the recent dramatic increase in the cost of rare earth elements, combined with a pre-existing upward trend for a broad base of other commodities, far exceeds our ability to find offsetting cost reductions. While we are exploring opportunities to reduce the content of certain rare earth elements that are used in the manufacture of hard disk drive components, we will be discussing with our customers, passing through what we hope are temporary surcharges related to upstream earth-based commodities. It’s important to note that for the relevant rare earth materials, there does not appear to be a significant supply constraint. And while we have a short-term concern over margin impact, we do not currently have a long-term concern.”

During the Q&A session, Seagate management explained that rare earths are about 2% of the cost of a hard drive due to usage of rare earths in the the VCM magnet and the motor. Management also indicated there remains high uncertainty as to whether the company can pass on the higher costs of rare earths to customers although Seagate does not need to wait for demand of its drives to surpass supply in order to raise these prices.

Seagate appears very optimistic that no real supply issue exists with rare earths. Management is particularly optimistic that U.S. mines alone (presumable Molycorp?) will solve the problem and bring prices down. They even went so far as to call current prices a “bubble”:

“…it doesn’t appear that there’s a true supply constraint here. There’s a lot of dynamics around owners of rare earth materials and processors of rare earth materials and who is controlling inventories at what level, as opposed to there’s fundamentally some shortage. If there was fundamentally a shortage, then I would think that the fact that price is supposedly representing supply and demand. If you effectively reduce supply or enormously increase demand, that would mean that there’s a sustained increase in price. I think this feels a little bit like a bubble…So I think our point is that right now, since it doesn’t feel like there’s a fundamental supply issue, that it probably works itself out. And by the way, if these prices stay high, guess what, there’s a bunch of U.S.-based mines that are going to come online again, and it will solve itself. It’s not like the stuff doesn’t exist. It’s just that a lot of mines were closed down when the prices fell below $75, whatever the magic price is, and we’re well above that right now. So I don’t think it’s a long-term issue.”

Management compared the price run in rare earths to a run they experienced with ruthenium in 2006 that lasted for 2006. I do not know about the dynamics of that market. I will need to research more closely what happened in 2006 to understand the specific similarities to today’s rare earth market. Stay tuned…

Disclosure: Author is net long Molycorp (MCP)

Education at California’s public universities gets more expensive again – UC has doubled in six years

For the second time in a year, University of California (UC) Regents voted in a hike in tuition. Tuition has now increased over 18% for the academic year and has now more than doubled in six years.

Interestingly enough, the Vice President of Budget and Capital Resources received approval for a 10% pay increase at the same meeting.

Tuition in the California State university system was increased 12%. At the same time, San Diego State’s president was approved for a salary 33% higher than the previous president. His salary is now a whopping $400,000.

At least administrators can continue to afford to send their children to California’s public universities!

For more see:
UC Regents hike tuition – again
Capitol Alert: UC regents vote to increase tuition
Cal State trustees raise tuition 12%

Bullard recommends targeting monetary policy at headline, not core, inflation

The Federal Reserve Bank of St. Louis just published an article written by James Bullard, a non-voting member of the Federal Reserve and President of the St. Louis Fed, called “Measuring Inflation: The Core Is Rotten.” It is based on a speech Bullard delivered two months ago to the Money Marketeers of New York University. It is a refreshing perspective on the use of core inflation for guiding monetary policy; it is also a bit surprising coming from someone on the Federal Reserve!

Bullard starts and ends with a critique familiar to those of us who insist food and energy prices should not be excluded from measures of inflation:

“One immediate benefit of dropping the emphasis on core inflation would be to reconnect the Federal Reserve with households and businesses who know price changes when they see them. With trips to the gas station and the grocery store being some of the most frequent shopping experiences for many Americans, it is hardly helpful for Fed credibility to appear to exclude all those prices from consideration in the formation of monetary policy…

…The headline measures of inflation were designed to be the best measures of inflation available. It is difficult to get around this fact with simple transformations of the price indexes. The Fed should respect the construction of the price indexes as they are and accept the policy problem it poses. To do otherwise may create the appearance of avoiding responsibility for inflation…”

(Compare and contrast this to Governor Frederic S. Mishkin’s insistence in 2007 that the Federal Reserve should care about headline inflation but focus on controlling core inflation in its public stance on monetary policy.)

I love the recognition that average consumers and businesspeople “know price changes when they see them.” This is Inflation Watch’s reporting philosophy and helps explain my emphasis on reporting the price changes of a broad range of products and services.

Bullard makes some key points to argue that headline inflation can and should be the focus of monetary policy. While I agree with his overall thesis, I do take issue with some of the points (my comments in bold):

  1. Monetary policy can be adjusted to accommodate the extra volatility in headline inflation by, for example, focusing on year-over-year changes.
  2. The relationship between core and headline inflation is unclear and even changes over time, making it more difficult to comprehend the optimal policy response. Me: This was an interesting point since the Federal Reserve’s statements usually imply the Federal Reserve tunes policy for core, not headline, inflation anyway. Currently, Ben Bernanke has all but absolved monetary policy of any impact on commodity prices.
  3. The Federal Reserve cannot directly influence supply and demand dynamics for any particular product in the inflation index, so it is not sufficient to ignore prices that are supposedly out of the Federal Reserve’s control. Me: I understand Bullard’s point, but I also think providing cheap money that traders can easily borrow to bid up the prices of goods and services is a strong and sufficient influence. The Federal Reserve definitely thinks it can directly influence housing demand and prices given its targeted efforts at lowering mortgage rates.
  4. When the price of one good goes up, another goes down as consumers adjust their demand to stay within their budgets. Increasing food and energy prices can thus force other prices down in the core index and further understate true inflation.

Bullard further notes that their is promising research into directing monetary policy at a specific subset of prices that households care most about, but it is too early to use.

Of particular interest to me was Bullard’s identification of a changing world where commodity prices will join the prices of medical care (and education) in outpacing the overall average inflation rate.

“…much of the contemporary worry about commodity prices is that relative price changes may be much more persistent going forward than they have been in the past…

…it is at least a reasonable hypothesis that global demand for energy will outstrip increased supply over the coming decades as the giant economies of Asia, particularly India and China, reach Western levels of real income per capita. If that scenario unfolds, then ignoring energy prices in a price index will systematically understate inflation for many years.”

(See “Preparing for Profits in a Resource-Constrained World” on implications for investing).

Given the limitations and blind spots of core inflation, Bullard makes a convincing case for directly targeting headline inflation with monetary policy. Otherwise, the Federal Reserve remains at risk for maintaining monetary policies that are too loose for too long.

Changing the measure of inflation to generate more government revenue

I read a short article in Planet Money that reminded me why I tend not to pay attention to official government inflation statistics. The government estimates it could generate $200B in extra revenues over a decade by making the switch. This reminds me that the folks generating the index essentially have a vested interest in the numbers themselves or at least can face political pressures to calculate and/or interpret them in ways favorable to policy.

See “The Wonky Inflation Tweak Worth Over $200 Billion” for more.

Bacon prices expected to soon hit $6/pound

Retail bacon prices were $4.77 per pound in May and are expected to hit $6 per pound soon. In a somewhat tongue-in-cheek article, CNBC reports in “The Crisis We Should Be Panicking About: Bacon Prices“:

“The bacon community is outraged…I think they’ll make cutbacks other places — stop buying other things so they can afford bacon..Get some good tomatoes and lettuce and forget the other stuff…”

Bacon prices have increased because “…hog farmers have pared their herds due to high feed costs after corn prices hit a record near $8 a bushel last month.”

July 4th BBQs are more expensive this year

CNBC reports on food inflation in the context of the typical BBQ. If your typical BBQ is a cheeseburger, baked potato, and beer, you are paying 8.4% more this year than last year.

Other points from the video on year-over-year price changes:

Ground beef up 16.7%
Sirloin steak up 6.9%
Boneless chicken breast down 4.0%
American cheese up 3.6%
Head of lettuce up 14.9%
Tomatoes down 6.5%
White bread up 8.3%
Potatoes up 21.4%
Wine up 0.4%