Why Jumps In Commodity Prices Spell Rebound

Economists, eager to confirm the recessions demise, have been keeping an anxious eye on industrial commodities. The reason: No recovery has ever taken place without an appreciable firming of industrial raw-material prices, which usually spurt higher as rising demand lifts the economy out of recession.

Until recently, the picture was ambiguous. The Journal of Commerces price index of 18 industrial commodities, for example, rose sharply early in the year, but hit a plateau in February and early March. And the Commodity Research Bureaus widely watched spot-price index mf 13 industrial raw materials continued to slide until late February.

In mid-March, however, materials prices began to rise again, with both the Journal of Commerce index and the Commodity Research Bureaus measure touching their highs for the year in the last week of the month. Joining the parade to higher ground have been such cyclically sensitive materials as rubber, lumber, copper, zinc, tin, aluminum, and steel scrap.

Indeed, if the latest price jump heralds a more vigorous upswing, then several developments should follow in short order: First, purchasing agents, who have been keeping their stocks at razor-thin levels, should start to build inventoriesboth to meet rising demand and to beat future price hikes. Second, materials prices should continue to rise in response to growing inventory demand. Finally, such price hikes should boost the profitability of suppliers.

The biggest threat to the recovery as this scenario unfolds is that fear of inflation may spook the financial markets and cause a premature shift toward restraint by the Federal Reserve. In fact, several economists have recently warned that inflationary pressures are rising.

Edward Yardeni of C.J. Lawrence Inc. notes, however, that relatively little commodity inflation at the start of a recovery is normally passed on to consumers. Companies find that productivity gains more than offset their materials costs, allowing them to earn more while limiting price hikes, he says.

Meanwhile, continuing economic slowdowns overseas, particularly in Germany and Japan, should put an anchor on materials prices, even as the U.S. recovery quickens. Indeed, in light of the ongoing sale to the West of vast stockpiles of materials by the former Soviet Union, the threat of accelerating commodities inflation appears negligible.

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