Commodities Fall From Grace

They're out as a leading indicator

Industrial commodity prices, which have long been regarded as a key guide to emerging U.S. economic and inflation trends, are losing some of their charisma. The Conference Board, which is now responsible for compiling the composite business-cycle indicators that formerly were issued by the Commerce Dept., says it is dropping changes in sensitive-materials prices from the index of leading indicators.

Since materials prices carried the most weight in the 11-component index, that's no small move. But as BUSINESS WEEK has noted (BW--Feb. 12), plunging materials prices badly distorted the leading index last year, causing it to signal a weakening economy when the rest of the index was strengthening. That's not something the Conference Board's experts could ignore.

One reason industrial commodity prices have lost predictive power seems to be the shifting composition of U.S. output toward services and high-tech items with low commodity content. Consumption of spot commodities, which ran as high as 10% of nominal gross domestic product in the 1970s, was down to 4% by the mid-1980s and is probably even lower today. As the share of commodities in the GDP of advanced nations has shrunk, the link between commodity prices and both inflation and growth in those nations has weakened.

At the same time, rapid industrial expansion and infrastructure investment in developing countries, particularly in emerging Asia, are generating heavy demand for industrial raw materials. With Eastern Europe and Latin America joining the development parade, that demand will continue to grow.

Thus, though many economists now regard shifts in commodity prices as poor guides to near-term economic trends in the U.S., they see them as increasingly important indicators of global economic activity. And from that standpoint, observes Robert J. Barbera of Hoenig & Co., the recent declines in raw industrial-materials prices suggest that the expected pickups in Europe and Asia "continue to sputter."

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