COMMODITY MORNING CALL: CRUDE 112.24 +0.15%; COTTON 94.97 +0.81%; BDI 651 -1.66%

Brent crude prices were broadly unchanged during the Asian session, traders looking towards US job data published later today. See this weeks economic calendar for more information.

Cotton futures gained ground over night as commercial and investment funds built long positions. According to ICE Futures open interest has risen over 10,000 lots over the past three sessions to 178,051 lots on 1 February. The latest data from the CFTC is published at 20.30 GMT and charts will be available on Monday on Materials Risk. See here.

Producer price inflation easing but rising commodity prices are a risk to margins

The latest UK manufacturing data from Markit/CIPS suggest the sector started 2012 in good health with output expanding at its fastest rate for eight months. Although output is up the key factor manufacturers will be concerned about is their margins, which have been squeezed recently in the face of stiff competition from domestic and overseas manufacturers and weak pricing power. So, the third straight month of declining input prices will be of additional relief to UK manufacturers. Indeed, January marked the steepest rate of decline in UK input costs since June 2009 with manufacturers reporting lower costs for metals, packaging, plastics and timber in particular.

The recent relief to manufacturers margins is likely to be short-lived however. Commodity prices, in dollar terms fell by 15.8% (14.6% in sterling terms) in the past year, according to the Economist commodity price index. The price declines were led non-food agricultural commodities such as cotton which fell by 33.2% and metals which decreased by 11.8%. However in the past month or so many commodity prices have rebounded as fears over the European debt crisis and concern over end market demand appeared over-done. In dollar terms total commodity prices rose 4.4% in the past month (5% in sterling terms), led by metals which have seen prices rise by 9.7%.

The broad volatility in spot commodity prices rarely impacts manufacturers bottom lines directly. Depending on the size of the business and the degree to which it is exposed to commodity prices manufacturing firms will use a combination of contracts, forward buying and hedges to reduce their exposure to price volatility. Nevertheless the recent increase in commodity prices is likely to present a substantial headwind when contracts come up for renewal later in the first quarter.

The Markit/CIPS data for the UK also revealed that a shortage of certain inputs and shipping problems led to delivery lead times lengthening for the third consecutive month. A shortage of key inputs and materials is likely to be a big problem for a manufacturer looking to complete and order under certain time pressures and may mean the manufacturer has to manage both higher and more volatile input prices. With commodity supply chains becoming increasingly inelastic, small changes in demand can quickly lead to shortages and price increases. Indeed, in the recently published EEF Executive Survey 2012 key commodity shortages were identified by over 80% of manufacturers as the key risk to growth in 2012.

But how can companies seek to manage this risk? The survey reveals that companies are seeking to maintain ever closer relationships with both customers and suppliers, increasing collaboration and forward planning or seeking to reduce their risk further by increasing the number of suppliers.