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Falling Commodity Prices Can Be a Tailwind for Automakers

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Falling commodity prices

According to estimates, raw material costs make up more than 45% of a vehicle’s production cost. Commodity prices are a key driver of automobile companies’ performance. In this part, we’ll explore the recent trends in major commodities and see how commodities prices might be a possible tailwind for automakers including General Motors (GM), Toyota (TM), and Honda (HMC).

Currently, Toyota forms 1.16% of the Vanguard FTSE All-World ex-US ETF (VEU).

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Steel prices crash

The automobile industry uses high-grade steel products such as galvanized steel and high-strength steel for the body of vehicles. These products are costlier than standard grades of steel. Steel prices in the United States (SPY) have corrected sharply over the last six months. Steelmakers such as AK Steel (AKS) and ArcelorMittal (MT), which are major suppliers to the automotive sector, have seen their earnings plummet in the last two quarters.

While falling steel prices are negative for steel producers, automobile manufacturers stand to gain from lower input costs.

Copper and aluminum

Copper and aluminum are the other two key commodities that go into making a vehicle. Both copper and aluminum are trading near their six-year lows. The chart above shows the recent correction in copper prices. Falling commodity prices are a possible tailwind for automobile manufacturers.

It’s important to note that not every fall in commodity prices is reflected in auto companies’ production costs. Automobile companies source most vehicle components from auto ancillary companies such as Delphi (DLPH). These are sourced under long-term supply contracts.

Having said that, a lot of these contracts have a “pass through” component wherein changes in commodity prices are finally passed on to the vehicle manufacturer. This applies for both falling and rising commodity prices. Moreover, automakers negotiate prices with auto component companies on a regular basis. The new contracts reflect changes in commodity prices.

Meanwhile, automakers are currently negotiating fresh labor contracts with labor unions. We’ll discuss this in detail in the next part of our series.

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