What Commodities Prices Are Saying About Inflation

By Ryan Dezember, Joe Wallace and Andrew Barnett

Prices for the building blocks of the economy have surged over the past year. Oil, copper, corn and gasoline futures all cost about twice what they did a year ago, when much of the world was locked down to fight the spread of the deadly coronavirus. Lumber has more than tripled.

A lot of investors would probably see this chart and say it screams inflation.

Soaring commodity prices have stoked fierce debate on Wall Street and in Washington, D.C. over inflation and whether the fiscal and monetary policies intended to buffer the economy during the pandemic might now risk hobbling the recovery.

At the heart of the debate is how much of the climb in commodity prices can be attributed to transitory, temporary shocks that should ease as the world's economy moves further from lockdown, and how much of the rise will last and spread to other things.

In many markets, the factors driving up prices appear fleeting. The economic reopening has been bumpy. Inventories are depleted, leading to big restocking orders and putting premiums on near-term deliveries of raw materials. Supply lines are jammed, creating pockets of scarcity and adding costs that are passed on to consumers. Some of the price gains seem sharp but have only just completed their recovery from last spring's pandemic market panic.

Lumber

Even the pandemic's hottest commodity, lumber -- a market in which demand is tied to interest rates and home prices -- has supply issues unique to the wood-products business that have helped fuel the gains.

Prices for lumber soared to more than four times their normal level during the pandemic.

Fiscal and monetary policies that have padded American bank accounts and kept money cheap have propelled the rise. So has a shortage of sawmills relative to the last time so many houses were being built.

The Fed has stoked the hot housing market by holding interest rates to near zero, keeping mortgage payments low. Rising home prices and low rates have helped those who owned homes refinance and pocket cash without adding much to payments. Mortgage-finance firm Freddie Mac estimates that Americans last year withdrew nearly $153 billion from their homes in cash-out refinancings, much of which has been spent in a remodeling boom.

Sawmills shut down like most other businesses early on in the pandemic, but they ramped back up toward capacity. U.S. wood-product output returned to pre-pandemic levels in December.

Yet it remains about 15% lower than the 2006 peak, the last time housing starts were so strong. That housing boom turned out to be a bubble that nearly sank the global economy when it burst. Sawmills suffered through a slow recovery. There were closures, consolidation and not a lot of investment in new capacity, setting the stage for surging prices during the next housing boom.

Industrial metals are another prime beneficiary of the reopening economy and a lack of investment in new mines since the last price bust.

Copper

Copper, closely linked to global growth because of its use in housing and electronics, has never been more expensive. Prices have soared above $10,000 a metric ton and recently topped the previous high, from 2011.

Record imports by China, which quashed the coronavirus faster than the West and went on a commodities buying spree, initially powered industrial metals higher. Now Americans are spending their savings and stimulus checks on houses, renovations and consumer goods that make use of the metal. Meanwhile, boosting production at mines takes months, and work at many was disrupted by Covid-19.

But behind the gains, some analysts also see a rush into speculative bets on everything from reopening to electric cars. Elevated prices are prompting some buyers in China, which accounts for half the world's refined-copper consumption, to cut back. And the gap between spot prices and those for copper delivered in three months suggests there isn't a shortage.

And then there are some increases that aren't quite what they seem.

Gas and oil

Gasoline futures prices have doubled over the past year as the economy has reopened and the temporary shutdown this month of the East Coast's main pipeline for refined fuels led to regional price jumps and shortages. Still, gasoline prices aren't far out of line historically.

Gasoline futures in New York have averaged $2.13 a gallon this month, 6.5% above the average May price from 2001 to 2019.

The price at the pump also has a lot to do with state and local taxes, and the cost of getting fuel to filling stations.

It is a similar story for crude oil. West Texas Intermediate, the main U.S. price, has cost $65.08 a barrel this month, 19 cents shy of the average over the past two decades, excluding 2020 when prices tanked amid the pandemic's shutdowns.

Shipping

Bottlenecks in the shipping industry are giving some commodity prices a leg up.

The pandemic -- and the surge in demand for goods sparked by stay-at-home orders -- threw supply chains into disarray. In the container shipping industry, the disruption remains acute.

That feeds into higher prices for commodities such as tin and sugar in two ways.

Traders face weekslong delays to move materials from Asia to the U.S. and Europe. The result is localized shortages in the West, just as demand is climbing. Plus, traders are paying several times more for a berth on container ships than on the eve of the pandemic. They pass that cost on to customers in the form of higher commodity prices.

The cost of transporting commodities such as iron ore and coal in bulk is climbing, too. The Baltic Dry Index, which tracks rates along 20 sea routes, recently touched its highest level since 2010. Still, it is well below where it stood during the China-led commodities boom of the 2000s.

Corn

Corn is a good example of a commodity sent soaring by low supplies and transportation problems.

Near-term corn futures are much higher than those for later in the year. That is unusual. The remnants of the previous year's harvest usually cost less than the coming autumn's crop this time of year. When near-term futures shoot up like they have, it is usually because of a big shock to either supply or demand, as in 2013 after drought withered the U.S. crop and prices hit records.

This time it is a drought in South America that has left the global market short of supply. Meanwhile, demand is rising. U.S. drivers are returning to the road, meaning more corn blended into motor fuels as ethanol. China is expected to import about four times what it normally buys from abroad as it races to fatten millions of hogs to replace those killed to fend off an outbreak of African swine fever before the coronavirus pandemic.

And one commodity isn't marching higher, just when you might think it would.

Gold

Often touted as an inflation hedge, gold has fallen about 1% this year to $1,881.30 a troy ounce, despite a recent uptick in prices. Gold surged to a record in August, lifted by supply disruptions and investors' worries about the pandemic's duration. Big-name investors including Ray Dalio and Paul Tudor Jones touted its potential protection against a stimulus-fueled inflation spike. It has fallen about 8% since.

Analysts said that is mainly a sign investors aren't anticipating that consumer prices will surge beyond the Fed's control. After adjusting for inflation expectations, yields on 10-year Treasury notes have climbed for much of this year. Since gold pays no income, some investors said, it tends to struggle to compete with yield-bearing assets when so-called real yields on Treasurys rise.

Write to Ryan Dezember at [e-mail], Joe Wallace at [e-mail] and Andrew Barnett at [e-mail]

(END) Dow Jones Newswires

05-20-21 0914ET