Downturn in Commodity Prices Will Not Reduce Producer Prices
When costs rise, the processors pass them along to consumers. All of these transactions are modulated by the various elasticities of both supply and demand.
Thus the index is different than the one I discussed in relationship to the Producer Price index (PPI) in March 2011. But, in homage to Raymond Chandler and other film noir auteurs, while the players change, the game remains the same. There is no demonstrable link between lower CCI levels and lower PPI readings. Please note that I said “lower" -- as you can see in the chart below, the history of this index has spent most of the time in downtrends, with one between 1956 and 1971 and another between 1980 and 2001. The PPI rose through both downtrends. The PPI also rose during the 2002-2011 bull market in commodities, the one dubbed a “super cycle” by various gasbags, but at a rate not materially different from the rate it rose in 1980-2001.
If I did not label the chart above and simply asked you whether the blue bars led the pink columns higher, your answer would be “No.” However, the indelible mental association between higher commodity prices and higher producer prices remains, and I think it always will.
The Mystery Lead
So saying, the monthly returns on the CCI lead the monthly returns on the PPI by one month, highlighted with the bright green column in the chart below. While the data are what they are, this is economic nonsense of the first order: The commodities underlying those futures contracts will not be delivered for months and will not move through the processing chain until later. The quick reaction to visible futures prices may represent management gamesmanship. How many times have you heard some excuse about a consumer goods company, say Procter & Gamble (NYSE:PG), raising prices on coffee and blaming it on higher coffee futures prices? You take what you can get in this world.
Who Benefits From Lower Prices?
The real reason a lower CCI will not translate into lower producer price growth is that processors capture most of the economic rent from lower prices in the form of higher margins. The actual producer gets stuck with the lower price. When costs rise, the processors pass them along to consumers. All of these transactions are modulated by the various elasticities of both supply and demand.
There is a reason why no statues have been built to the proverbial middleman; after a while, non-middlemen start to get grumpy about this heads-I-win/tails-you-lose behavior. Perhaps this is why middlemen industries susceptible to Internet disintermediation have been pressured over the past two decades. You can replace a broker with a website, but try doing it with a refinery or metal-processing plant. These materials processors have retained a great deal of pricing power.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.