The fallout from high commodity prices will be unequally distributed and determined by whether one is a buyer or seller of commodities. The level of commodity input into finished goods and the ability to raise prices will determine how serious the impact will be for commodity users.
Low steel costs, for instance, are certainly better than high steel costs for automakers. But steel is a relatively small part of a car's cost, and the woes of Detroit's Big Three go far beyond steel prices (oil prices and labour costs for example). Baked goods, cereals, meat, poultry, eggs and dairy products all contain, directly or indirectly, large amounts of corn or wheat, so the impact of higher prices for those grains is widely felt among food processors. And the high price of oil will clearly be deleterious for the refining or airline industries, where oil is a major input.
The impact of rising commodity prices on US consumers has been more straightforward. Prices for gas, home heating oil and food have skyrocketed in the past year, boosting inflationary fears and crimping discretionary spending. Higher commodity prices don't account for all of the present economic slump (falling home prices and rising unemployment clearly play key roles), but they don't help either. How high and how fast commodity prices rise will continue to be a worry for consumers and business alike this year.
The speculation factor
One of the most frequently voiced suspicions concerning commodity prices is whether they're being manipulated higher by speculators. There is no easy answer to this. Many commodity prices have risen for reasons clearly evident. Rising demand from India and China, for instance, has spurred on higher metal prices. The same can be said for oil, while a growing worldwide demand for food and for corn-based ethanol has boosted agricultural prices.
But the volatility of commodity prices leaves a deep suspicion in some corners of the financial community that it's not the traditional, commercial end-users of commodity futures contracts, options and other derivatives that are responsible for pushing prices higher. An increasing number of hedge funds, pension funds and other large investors are buying commodities in search of better returns than other investment vehicles ù stocks, bonds and real estate ùare now providing. Trading volumes have increased greatly. The Futures Industry Association reports that 15.2 billion contracts were written in 2007, a 28% increase from the year before.
The other evidence of speculative forces is that some commodities seem priced far higher than fundamental supply and demand would indicate. We believe, for example, that the price of oil, now north of $100/barrel, will settle at roughly $91/barrel by year end. Over the longer term, we're expecting a price of $75/barrel, which is about 25% lower than it is today, as supplies remain adequate (although refining capacity remains a problem). Gold surged to more than $1,000/ounce and then, in early March, saw the largest dollar price drop in almost 28 years on interest rate worries. Macroeconomic factors play a part, to be sure, but such volatility cannot always be attributed to big-picture economics.
To curb undue market volatility, several US agricultural exchanges have already increased margin requirements (the amount of cash, as opposed to credit, required to buy a contract) on futures trading. The Chicago Board of Trade, the Kansas City Board of Trade and the Minneapolis Grain Exchange all recently raised the minimum margins for wheat futures, while the Chicago Board of Trade has announced higher margin requirements ù but also wider trading limits ù on corn, soybean and soy oil futures.
It is too soon to know if asking investors to plunk down more of their own cash to execute these trades will mark an end to the unsettling price volatility in agricultural commodities. But the idea that speculators are having an unhealthy influence on the markets is widely held. Late last year, government officials in India asked US and British authorities to consider a shutdown of oil trading on their commodity exchanges as a step to help curb the high price in India. That has not happened, of course, but the fact that the idea is even being broached shows how unpredictable commodity prices have become and how much governments worry that their economies will be at their mercy.
Inflation heating up
We expect the US economy to grow only 1.2% this year, but as higher commodity prices ripple through the economy, we could see the unholy alliance of low growth and higher inflation. That is not good either for commodity-dependent producers or for consumers, who, if they stop spending, will further depress the economy.
With oil still above $100/barrel, we expect gasoline prices to soar; $4/gallon gas is not out of the question in many areas as the summer driving season approaches. In February, according to the government consumer price index, gas prices were already 32.7% higher than they were a year earlier, while home heating oil was 33% more costly. Overall food costs climbed 4.6% during the past year, but several specific foods outpaced that gain: meat, poultry, eggs and fish (considered one category by the government) climbed 4.8%; cereals and grain products were 6.6% more expensive; fats and oil were up 7.7%; and dairy products prices rose 13.3%.
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