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Rising Consumer Inflation: The New World Order By Commodity

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By Dian L. Chu, EconForecast

Ever since the Great Recession, inflation has been put on the back burner, and deflation is seen as the greatest risk to the U.S. economy. Even as recent as Friday, Jan 7, Federal Reserve Chairman Bernanke told the Senate Budget Committee that low inflation/deflation was a concern, as well as unemployment (more on the jobs situation here.)

Deflation Concern Lead To QE2

In fact, Bernanke said the continuing high unemployment and low inflation had prompted the Fed's decision to purchase another $600 billion of U.S. government debt (QE2) to further stimulate the economy.

So far, the two inflation measures—Consumer Price Index (CPI) and Producer Price Index (PPI)—have not proven him wrong yet, as both indexes have been subdued in recent months.

Well, expect this nice peaceful trend to change as early as the December CPI and PPI releases this week.

Pent-Up Inflation Pressure Up The Supply Chain

During the past decade, Finished Goods PPI has risen roughly 35% while the CPI was up about 30%, which seems to suggest producers typically pass through most of the cost increases to the end market.

And news such as the following could only mean that there’s pent-up inflation pressure up the supply chain just waiting to be passed through:

  • Commodity prices jumped to two-year high on expectations for global economic growth and lower U.S. forecasts for agricultural inventories. 
  • The Food Price Index (See Charts Below) compiled by the U.N. Food and Agriculture Organization (FAO) surged 25% in 2010 and hit an all time high in December, at the level even worse than the food crisis in 2008. FAO acknowledged that this is unlikely the peak yet.

And if you think the 25% spike in food prices seems extreme, wait till you check out the Non-Food Agriculture (NFA) prices. The chart below from The Economist shows that the NFA prices were up almost 80% in 2010!  NFAs are agricultural materials with heavy industrial applications such as cotton and rubber.

Fixed-Price Terms Gone For Good 

Now, many (including Bernanke) posit that since raw materials now account for a smaller percentage of input costs, the record commodity price inflation will not necessary translate into price increases in end markets.

However, I believe that argument was valid in the pre-China era when commodity prices were relatively predictable, easier to hedge, labor costs were low in the developing countries where most of the manufacturing activity took place, and fixed-price and/or fixed-escalation clauses were the norm in contract terms.

Commodities Weigh on Cost Structure

However, with surging commodity prices, raw materials are becoming a bigger component of company’s cost structure. Many goods and services producers are now starting to index their supply contracts to input materials to adapt to this New World Order of Commodity.

For example, the latest such movement involved rare earth metals, which are key materials in Fluid Cracking Catalysts (FCC) used in the refining process to produce gasoline.

WSJ reported that due to the skyrocketing rare earth metals prices, chemical companies have started indexing the cost of their catalysts to rare-earth price movements. WSJ further noted that the added costs from rare earth metals, is not enough to make consumer notice, but enough to make some refiners to think about cutting production.

This just illustrates either the cost gets passed through, or there could be production cuts as a result--both translates into higher prices for consumers. .

Raising Prices Could Mean Losing Business

Basically, Fed’s QE has devalued the dollar while propping up everything from stocks to commodities, but with very little impact on the labor market. This has resulted in two totally disjoint pictures between the corporate profit and the general consumer/labor market.

The Standard & Poor’s GSCI Spot Index of 24 commodities has rallied 21% in the past year, and is expected to stay on the uptrend partly on expectations for global economic growth. Meanwhile, the spread between the 10-year note and Treasury Inflation Protected Securities (TIPS) which represent expectations for consumer prices, widened to 2.40%, near an eight-month high.

As inflation expectations and commodity prices are rising, corporations could face headwinds when they need to start raising prices, and lose business due to a still weak consumer market.

Respect the New World Order By Commodity

In today’s environment, the best way to hedge inflation is probably to invest--through patience and discipline--in commodities (see here for investment options) and stocks (via a broad index fund) on pullbacks. 

And keep in mind there are two things for certain--inflation will be steadily rising no matter what time frame you are looking at and prices of commodity and stock will have pullbacks.

Dian L. Chu, Jan. 12, 2010  | Vote for Me - Shorty Finance AwardFacebook PageGoogle Profile

 


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Thu, 01/13/2011 - 11:07 | Link to Comment whatz that smell
whatz that smell's picture

QE27: Deflation bubble bailout (inflation stamps)

QE28: Inflation bubble bailout (deflation stamps)

QE29: Momentum Trade bubble bailout (lemming stamps)

....

Thu, 01/13/2011 - 10:52 | Link to Comment RoRoTrader
RoRoTrader's picture

Nice call on that long OIL trade from Sunday night, Dian........

Thu, 01/13/2011 - 10:28 | Link to Comment alter ego
alter ego's picture

Hey folks we are suffering for the next Oil Shock.

 

How do Oil Shocks create recessions?

In Many ways, the most fundamental linkage between Oil shocks and economic recession is that Oil shocks always cause huge spikes in inflation and those spikes in inflation are accompanied by huge spikes in interest rates that eventually snuff off growth

 

Every Central Banker knows, even misleads Central Bankers as Alan Greenspan or Ben Bernanke will tell you that your borrowing rate is a mirror image of your inflation rate.

 

What drove that huge increase in interest rates?

What droves that huge in interest rates is the same thing that droves that huge increase in inflation. Almost all increase has been drove by only one component of the CPI Index, the “Energy Component”.

 

                                                Jeff Rubin

 

 

The infinite growth paradigm and finite energy:

 

We live in a infinite growth paradigm which requires growth forever, is not that Bernie Madoff made a pyramid scheme, the whole US economy is a pyramid scheme. The whole world economy ca not been sustained, because requires infinite growth.

But infinite growth collides with finite energy.

1)      First law of thermodynamics: energy can not be created or destroy. It can only change forms.

2)      Second Law, energy converts in only one direction from usable to unusable, that is called entropy, for every energy transaction, come energy is lost.

 

We have finite energy and you have a financial paradigm which requires infinite growth and we are in a point of human history where the infinite growth paradigm collides with something more powerful than money is.

 

                                                                        Mike Ruppert

 

 

Thu, 01/13/2011 - 09:52 | Link to Comment blindfaith
blindfaith's picture

"In today’s environment, the best way to hedge inflation is probably to invest--through patience and discipline--in commodities"

You mean the best way to drive up (inflate) the price of everything is to drive up (inflate) the price of the raw goods...right? 

Am I missing something?  Hedge/invest in glod or silver if you wish, but how does driving up the price of goods help your broken country in the end?

This is a fantasy. 

Want to invest in something, invest in chain link fence and barbed wire manufacturers.  There will be a big calling for those goods if this commodity shit keeps up.  (excuse the language, but it fits here).

Thu, 01/13/2011 - 10:00 | Link to Comment AnAnonymous
AnAnonymous's picture

Yep, you are missing something. The part telling that the most valuable side of the deal is made through screwing those who do not hedge in commodities. That is where the good in the deal comes from.

Thu, 01/13/2011 - 09:59 | Link to Comment Moonrajah
Moonrajah's picture

Nah, just go for the bottomline - guns, crowbars and baseball bats. It will all boil down to them, methinks.

Thu, 01/13/2011 - 08:10 | Link to Comment eigenvalue
eigenvalue's picture

Another piece of worthless Monday morning quarterback "analysis". Everybody knows we should invest in commodities.

Thu, 01/13/2011 - 09:57 | Link to Comment Moonrajah
Moonrajah's picture

By "everyone" do you imply yourself and a couple of your cubicle co-workers?

Thu, 01/13/2011 - 07:45 | Link to Comment Sudden Debt
Sudden Debt's picture

Just wait untill the farmers rise and demand a fair price for their products.

That could also tripple prices.

Thu, 01/13/2011 - 08:57 | Link to Comment Arch Duke Ferdinand
Arch Duke Ferdinand's picture


""Just wait untill the farmers rise and demand a fair price for their products.

That could also tripple prices.""

...Which is why Canada's, Geneva of Switzerland, becomes the most important "Safe" city in North America.

It is the key gateway to Canada's Western Provinces plethora of commodities.

All four Western Provinces total only 12.5 million citizens...

http://seenoevilspeaknoevilhearnoevil.blogspot.com/2011/01/vancouverthe-geneva-of-switzerland.html

Thu, 01/13/2011 - 08:28 | Link to Comment ciscokid
ciscokid's picture

Farmers are paid almost nothing for their products.

Thu, 01/13/2011 - 07:35 | Link to Comment Popo
Popo's picture

As bad as inflation is in the US -- it's *nothing* compared to what it's doing to emerging markets.

...and the expectations for EM's is that it hasn't even started yet...

e.g. http://thaifinancialpost.com/2011/01/13/inflation-in-thailand-to-skyrocket/

 

 

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