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Minyan Mailbag - Pricing Power, Commodities and Inflation



Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

All the inflationists were screaming INFLATION when Corn went parabolic

Were any of them screaming about deflation during this plunge?

Soybeans - same story

Are grains more a function of weather and how much was planted or a just cause in the inflation/deflation debate? Personally I think the former.

What about copper?

Now with copper one can easily debate the merits of inflation vs deflation with a lot more conviction than food. The question to ask now is this: Is the rise a result of demand increases in China or a result of the falling U.S.$? How about both? Both is what I think but a more important question to ask at this juncture is this: with worldwide growth slowing and U.S. leading indicators falling 3 months in a row, is this a very stable looking chart? In other words, what is the upside vs downside risk here? I suppose IF China keeps growing in spite of U.S. growth slowing considerably and IF copper keeps rising in the face of that, one might very well ask: Is the rise in copper a function of U.S. inflation or rampant speculation in China? Commodities are priced at the margin. If China demands copper, copper will keep rising. But... does that necessarily mean prices will end up in finished goods?


There is no denying this powerful chart


1) How much is due to geopolitical concerns?

2) How much is due to peak oil? If there is declining supply with up trending demand just what would one expect? If that is the reason, can that properly be called inflation? Is that symptomatic of inflation any more than bad weather and poor crops caused corn and beans to go parabolic then crash when there was over planting and good crop weather?

3) There is no doubt that easy money in the U.S. led to an investment boom in China. There is no doubt with both oil and copper that U.S. monetary policy led to booms in steel, copper, and oil. But.... If oil continues to rise and Chinese demand continues to grow and demand in India continues to grow and demand in Brazil continues to grow, will any U.S. interest rates within reason stop the march of oil if we are indeed in a peak oil situation? I think not. If we try, we will cause a worldwide depression in short order IMO.

4) If U.S. demand falls, can the boom in China go on unabated, especially in the face of rising oil? Is that chart really stable?

5) If oil keeps rising, does it act more like inflation or does it act more like a tax? Everyone seems to have a firm view on that subject. Personally I think the correct answer is this: It depends. Not meaning to sound wishy-washy let's look a little further. IF rising oil prices leads to higher prices on finished goods and higher wages granted to employees then rising oil is indeed inflationary. If on the other hand, rising oil prices are not passed on in the prices of finished goods and wages do not rise to cover the costs then rising oil acts more like a tax. OK, what environment are we in here? That is easy: real wages have declined for 4 years, we are losing jobs to India and China, and 3 years into a recovery with record stimulus we have not done much but accumulate debt. IMO, it is clear that in our current environment that rising oil is a tax and is deflationary not inflationary.

Let's look at some finished goods.

We all know that PCs and TVs and gadgets are cheaper but what about other stuff?

Coke (KO:NYSE):

Merrill Lynch noted in a research report the day following Coke's confessional that carbonated soft drink volumes fell 5.1% in August, while pricing increased 3.6%. The drop in volume accelerated from last month's 4.6% decline and is well below the year-to-date drop of 3.6%.

No surprise here to me.

Coke raised prices and demand dropped.

General Mills (GIS:NYSE):

Earning at General Mills for the quarter that ended August 29 fell 19% from last year's level. Part of the decline was due to restructuring charges, but even excluding the charges, EPS fell to $0.55 from $0.59. These estimates were already guided lower once. In June, the company told analysts that earnings for the full year were going to be lower than last year. The decline was due to higher costs; most notable was the $70 million in extra expense due to higher commodity costs. While the company announced that it was raising prices to offset higher commodity prices, the company had to honor discounts to grocery stores that were in effect before the announced price hikes.

Colgate (CP:NYSE):

Colgate said that increased marketing spending and higher raw material costs will cause earnings to be more than 10% below analysts' forecasts. Additionally, the company forecasts that higher raw material costs will remain high, but will not continue to accelerate higher. The personal products company also said that it plans to increase advertising spending in order to gain market share.

No surprise here to me.

Colgate is not even going to try and pass cost increases on.

General Motors (GM:NYSE):

GM and Ford (F:NYSE) announced that it will offer zero-percent six-year loans to help clear out 2004 model year inventory. This is smack in the face of hugely rising steel costs. Pricing power? Ha ha.

Home prices are up but some of that is the fact that sizes of homes has exploded in recent years. Much of it is indeed unreported inflation but the bigger question right now is: where to from here? With home backlogs stacking up and prices starting to fall, a mere 75 BP hike in interest rates was all it took to stall this economy. Soft patch? I doubt it.

It's funny. For 2 years everyone was worried about deflation and the double dip recession while the economy exploded. Now just as the economy is showing major signs of slowing all the economists are worried about inflation, not deflation, and all of the market "gurus" are forecasting huge market gains in spite of a rising interest rate, slowing economy, with no pricing power to boot. Amazing.

Minyan Mike Shedlock


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