Will commodity price rises trigger inflation in 2018?

As we begin our journey into 2018 then there has been one clear trend so far as Bloomberg has pointed out this morning.

The Bloomberg Commodities Spot Index, tracking the price of 22 raw materials, jumped to its highest since December 2014 on Thursday. The gauge has risen for a record 14 days in a row.

If we take a look at the underlying data we see that the index has rallied from just below 340 on the 11th of December to 361 as I type this and it has been pretty much one-way traffic. So perhaps ripe for a correction in the short-term but if we look further back we see that it is up 8% on a year ago and that this stronger phase began just under 2 years ago in mid January 2016 when the index dipped below 255. This leaves us with an intriguing conclusion which is that the commodities index saw a strong rally in 2016 just as we were being told inflation was dead as mainstream analysis looked back on the previous downwards trend.

Bloomberg is upbeat on the causes of this recent phase.

The strongest manufacturing activity since the aftermath of the global financial crisis is slowly draining commodities surpluses, sending prices to a 3-year high as investors pour money into everything from oil to copper.

“Rarely has the outlook for a New Year been as encouraging as it is today,” said Holger Schmieding, chief economist at Berenberg Bank in London.

With factories around the world humming, demand for raw materials is fast increasing.

That is an upbeat way of looking at the issue although of course it omits something that in other articles they tell us is important which is the use of finite resources. We get however a clue to their emphasis from this.

Where to make Big Money in Commodities, Energy

I particularly like the way that Big Money is in capitals. Anyway well done to those who had stockpiled commodities. Also there may be a misprint about the chief economist of Berenberg Bank being in London as of course Bloomberg readers will have been told that all such jobs have gone to Frankfurt although they may be further confused by the brand new shiny Bloomberg offices in London! Moving to the Financial Times we also see that good economic news is on their minds.

Markit’s global survey of manufacturing activity rose to a near seven-year high in December, fuelling optimism that 2018 could be another year of strong growth.

Crude Oil

The rally here poses something of a problem for economics/finance themes because as regular readers will recall we were told that the advent of shale oil production would prevent price rises. One part of the analysis was true in that they have indeed produced more oil.

The U.S. Energy Information Administration (EIA) expects U.S. crude oil production to have averaged 9.2 million bpd for all of last year. It expects U.S. crude oil production to average an all-time high of 10.0 million bpd this year, which would beat the current record set in 1970. ( OilPrice.com)

That is of course more than awkward for those who put Peak Oil theories forwards in the 1970s for a start. Moving back to the current oil price what was not forseen was that OPEC will not only announce production cuts but actually go through with the announcements leading to this.

however, oil prices rose steadily in the fourth quarter of 2017 to end the year at above $60 per barrel WTI and $66 per barrel Brent.

Brent Crude Oil nudged over US $68 per barrel earlier today or as high as it has been for two and a half years. At such a level we see that there is good news for oil producers of all sorts.Firstly there must be something of a bonanza for the shale oil producers with the cash flow style business model we have previously analysed. But also there will be all sorts of gains for the more traditional oil producers in the Middle East as well as Canada and Russia. There has been an irony in that the pipeline shutdown for the UK Forties field meant that Brent production could not benefit from higher Brent prices but that is now over.

Inflation

Last September an International Monetary Fund ( IMF) working paper looked at how oil price moves affected inflation.

 We find that a 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4 percentage point on impact, with the effect vanishing after two years and being similar between advanced and developing economies.

There was also some support for those who think that the effect is stronger when prices rise.

We also find that the effect is asymmetric, with positive oil price shocks having a larger effect than negative ones

The results also vary from country to country as the impact on the UK is double that of the impact on the United States although this may be influenced by 1970s data when the UK Pound £ would have acted like the Great British Peso on any oil price rise.

As an aside I would like to remind everyone of the way a surge in the oil price contributed to the economic effects of the credit crunch, something which tends to get forgotten these days. On that road the credit crunch era becomes easier to understand and the establishment mantra which this IMF paper repeats becomes more questionable.

The has declined over time, mostly
due to the improvement in the conduct of monetary policy.

A darker road can be found if we look at the impact of bank commodity trading desks back then because if as I believe they drove oil prices higher there is a raft of questions to add to the other scandals we have seen such as Li(e)bor and foreign exchange rigging.

Metals

There has been a raft of news about these hitting new highs and let us start with what Dr,Copper is telling us.

Copper gained 30%  in 2017 as it continues to recover from six-year lows struck early last year……… Measured from its multi-year lows struck at the beginning of 2016, copper has gained more than 70% in value. ( Mining.com)

Palladium has been hitting all-time highs this week. If we look deeper we see that metals prices have been rising overall as the CRB metals index which was conveniently at 800 this time last year is at 912 as I type this.

Comment

There are various factors to consider here but let me open with a word not in frequent use in the credit crunch era which is reflation. We are seeing a stronger economic phase ( good although there is the underlying finite resources issue) but how much of this higher demand will feed into inflation may be the next question? There have been signs of Something Going On as Todd Terry would put it. From the Composite PMI or business survey for the Euro area.

The pace of inflation signalled for each price
measure remained strong relative to their long-run
trends, however, and among the steepest seen over
the past six-and-a-half years.

Also for the UK services sector.

Input price inflation reached its highest level since
last September, with service providers noting
upward pressures on costs from a wide range of
sources.

Moving to a different perspective some seem to be placing their betting chips in the US according to the Financial Times.

Investors pour money into funds that protect against inflation

Also there will be wealth and GDP shifts in favour of commodity producers and from those that consume them. The obvious beneficiary is much of the Middle East but others such as Australia, Canada and Russia will be smiling and that is before we get to the US shale oil producers who have been handed a lifeline. It also reminds me that the Chinese effort to get control of commodities around the world and particularly in Africa looks much more far-sighted than us western capitalist imperialists have so far managed. That is something which will particularly annoy Japan which of course is a large loser as commodity prices rise due to its lack of natural resources as its own more violent and aggressive efforts in this field badly misfired in the 1940s.

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15 thoughts on “Will commodity price rises trigger inflation in 2018?

  1. I suppose central banks have caused quite a bit of commodity inflation by their never ending low interest rate policies. There is a lot of cash sloshing around the world looking for a better return on investment, consequently we see gambling on Bitcoin, commodities and almost anything that could be considered in short or finite supply. There are other factors as play such as cartels, political instability etc but low interest rates must be a contributor to higher commodities.

    • It does seem a very sad state of affairs that commodities are not seen as part of the manufacturing supply chain but a way for those with spare cash to enrich themselves. R

    • I think it’s a mixed and complex picture regarding low interest rates and commodities. Cheap money helps fund expensive extraction techniques like shale, which increases supply and holds down prices. This was compounded a couple of few years ago by the Saudi plan to drive down oil prices even further in order to put such new-fangled producers out of business!* Of course, you have to balance this against demand for commodities that is caused by monetary stimulus, but it’s definitely arguable that low rates had surprisingly deflationary effects, especially on oil, in the recent past.
      As far as the direction for commodity prices this year goes surely China is the biggest factor. It seems like they are trying tighten up credit which would suggest that commodity demand and therefore prices may be at or around the peak.

      *it may also have been an attempt to knacker the Russians. There is always a great deal of geopolitics bound up in the oil price.

  2. A surge in commodity prices often presages a downturn economically and a Bear market. It is of course one of the factors that triggers it. Reasons given for the late day surge in a Bull market is obviously cited as surging demand – but I do recall, like you, the extraordinary commodity surge prior to the financial crisis itself. I specifically remember a piece in the FT likening the effect to “squeezing a quart into a pint pot” to describe the flow of capital from equities into commodities.

    Stop press: Here is that article in FTAlphaville from 2008.

    https://ftalphaville.ft.com/2008/03/18/11652/commodities-the-big-fall-is-coming/

    • Hi Hotairmail

      Very impressive, do you have it filed away? I look for the one on Anglo-Irish Bank on FTAlphaville every now and then,,,,,,,,

      As to those days there was so much going on as for example UK interest-rates were in effect some 2% higher than Bank Rate. If you throw in the oil price surge it is no wonder the economy hit the skids. Sadly that sort of logic ( that the event is explainable and fixable) was not used by the central banks who dashed into a panic mode they have yet to escape. Also there should be an investigation into how oil and commodity prices were driven up so high.

      • “Do I have it filed away”? No, of course not. Google is your Mother. It is times like this that I think maybe, just maybe, I don’t yet have Alzheimers. The financial crisis and all its parts is still clear as a bell for me. As I suspect it is for you. Anglo Irish, Barclays, RBS etc….scum.

  3. The de-flationists have for years dismissed the fears of inflation from QE, but I think the $7 trillion or so created by central banks worldwide is going to have consequences, and the most obvious is inflation, we all know the arguments about the money created being held in an account at the Fed and then cancellled when the bonds are run off(cancelled or not rolled over) and the interest being re-credited to the treasury, but this together with ZIRP has created so many bubbles the current situation is described as the “everything bubble” Da Vinci’s, classic cars, property, stocks, bonds, cryptocurrencies, all in a bubble.

    It would seem inconceivable that with so much stimulus and money searching for a return or yield, prices in general would remain stable, and so finally inflation is taking off, but of course central banks either will refuse to acknowledge it or deliberately ignore it, and say they do not want to raise rates too quickly for fear of killing off the recovery.

    This time will be different, the last period of high inflation in the early seventies also saw wages keep up(thanks to tade unions), unions now are virtually impotent and wages are almost static, falling or rising less than inflation. As inflation accelerates(especially in food, energy, everyday items), real incomes will drop precipitously.

    And yet still the general population cannot make the link between their cratering standards of living, the decline in their purchasing power and the central banks that cause it.

    Enter the solution to everyones problems stage left – The Labour Party and Universal Basic Income, when things start to really get out of control – how about a “huge tax rebate” from the government – who will refuse that or argue against it?(helicopter money) , of course it will be emphasized that it is purely a temporary measure due to the emergency of the time, everything will seem lovely until prices rise even faster, and then rise again in anticipation of the next payment.

    Pretty soon, people will realise that even with the payments, they are getting poorer and poorer each time, as prices are going up faster and faster, and the amount the payment buys each month gets less and less.

    Eventually there will be cries of protest from MP’s who will insist that the amount of the payments will have to increase as families cannot survive, and so it goes on. This is how currencies die, slowly at first and then very quickly to quote the old joke.

    Or to sum up the above in one sentence:

    “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
    Ludwig Von Mises.

  4. if the bubble bursts now with “emergency” interest rates…. what can the TBTF Banks do ?

    Can the BoE go for BIRP / ZIRP considering that Japan shows thats not going to work ?

    interesting times …..

    forbin

    • I think that you will find that the financial colossus Mark Carney has it all figured out as he has so masterfully led us so far. Of course, if he doesn’t, we will then know that no one could have foreseen the bubble bursting.
      At least we can then entertain ourselves by counting the number of times the following words appear in his speeches:
      1. Unforeseen;
      2. With hindsight;
      3. All available measures;
      4. International dimension;
      5. Brexit;
      6. Political uncertainty.
      Perhaps less frequently will appear:
      1. Goldman Sachs;
      2. Sorry;
      3. My mistake.

    • 1.NIRP(negative rates).
      2.Helicopter money.
      3.Universal Basic Income.
      4.Massive boost to government spending.
      5.Devalue the pound(will be taken care of by the above).
      All the above are inflationary, the markets are already anticipating and discounting such measures now.
      Popcorn, I’m afraid is going to cost a lot more as well:(

  5. Kevin, a great reply and I like your enthusiasm to forecast the future. Nothing you say is inconceivable and it does involve the Govt in getting ever more creative with voter coping mechanisms. As we see the baloney unfold we will know that your underlying causal arguments are confirmed.

  6. Inflation is everywhere and always a monetary phenomenon. Commodity price increase don’t cause inflation unless the Central Bank increases money supply. Think of a gold based currency, if oil prices rises, then there is less gold to buy other things, so there prices must go down and on average there is no inflation. This is the same with fiat money, if the supply of money is not increased then no overall inflation.

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