The end of the beginning

Sale.jpgLast week’s BASF announcement marked the end of Phase One of the downturn. This began over a year ago, with the first signs of financial crisis. Now, we will move into Phase Two – a long, multi-year recession, which will probably include several bear-market rallies.
The end of this “beginning” Phase is seeing a disastrous fall in demand, and fire-sale pricing, caused by three main factors:
Destocking. Customers are having to unwind the “extra” volumes bought ahead of price increases during 2007 – H1 2008. Plus, they are also having to unwind any panic purchases made in June/July, when oil was widely expected to be on its way to $200/bbl.
Demand destruction. Whilst all this extra inventory was being built, end-user demand into the key housing / construction and auto sectors was actually declining. So companies are also now having to adjust their stocks to this new lower level of demand.
Year-end factors. Companies are understandably anxious to exit 2008 with maximum cash on the balance sheet. This is reducing demand still further, albeit on a temporary basis.
The first factor meant many companies were holding 20% extra stock by the end of July. Now, they not only have to work-off this volume. But they are also having to adjust to ongoing demand levels that are 20% below 2003-7 levels. Effectively, therefore, the industry has suddenly hit an “air pocket”, where physical demand has temporarily appeared to vanish.
The key question, of course, is what happens next? Demand is unlikely to resume previous growth levels for some years to come. But every now and then, there will be sudden rallies, when stocks have become too low.
Such a rally could well take place in Q1, with demand “surprising” on the upside. But it would be very risky to assume this rally also marked the end of the downturn, particularly if credit markets remain difficult.

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