Why Bond Bulls Need to Wake Up, Smell the Coffee
Anyone trying to sell you a bond nowadays will tell you that the recent jump in long-term interest rates is a false alarm, at least as far as inflation is concerned. There is no inflation to speak of, the bond bulls insist.
Unless, of course, you’re a coffee drinker. The price of a pound of coffee on futures markets has rocketed from 72 cents at the start of the year to $1.33 now--an 85% gain--as bean production has fallen drastically in South America and Africa.
As a result, General Foods just decided to boost the retail list price of a can of regular Maxwell House coffee from $2 to about $2.50, or 25%.
Commodities are the proverbial fly in the ointment of the no-inflation crowd this year. Though prices of crops, metals, wood products and other raw materials are constantly in flux, their general direction has been unmistakably up lately.
The Commodity Research Bureau index of 21 key commodities shot up on Monday, causing a mini-panic in the bond market. On Tuesday the CRB fell 1.5%, but it’s still near a 3 1/2-year high.
The CRB index is heavily weighted toward grain prices, so it has been surging in recent weeks as fears about a dry Midwest spring have driven crop futures higher. Meanwhile, another commodity index--the Journal of Commerce Industrial index, which tracks prices of metals such as aluminum and zinc--also has been advancing strongly.
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So far, rising commodity costs aren’t translating into a higher consumer price index. The bond bulls argue that commodities’ rally is a blip, and that the world economy isn’t strong enough to support higher raw materials prices for long, let alone higher prices for finished goods.
Some contend commodities’ recent gains are merely the work of professional traders, not the result of “real” demand. There is some truth to that. Caroline Van, analyst at hedge-fund tracker International Advisory Group in Nashville, says her firm is increasingly hearing from big investors who want to place money with hedge funds that trade commodities. “They’re interested in commodities as a (new) asset class,” Van says.
In Santa Monica, well-known hedge fund manager Mark Strome believes metals such as copper, nickel and aluminum are poised for dramatic price rises. “I think this is the opportunity” in financial markets in ‘94, he says.
But for metals prices to surge, Strome concedes, real demand--from busier factories churning out more goods--will have to be there worldwide.
Robert Genetski, who runs a Chicago economic advisory firm bearing his name, believes that stronger-than-expected demand for goods and services will in fact be the No. 1 surprise of 1994.
The Federal Reserve Board, Genetski argues, allowed money to be so loose for so long (1991 to 1993) that the seeds of robust future business and consumer spending are already sown.
While the conventional wisdom is that the Fed’s interest rate hikes this year will slow the economy, Genetski points to the surge in bank loan demand from business borrowers in recent months as evidence that the economic expansion is gaining steam, not losing it. Commercial and industrial loans outstanding, which plunged from 1991 through ‘93, have jumped to $605 billion from $585 billion at Jan. 1, even as loan rates have risen.
Higher demand for goods and services--not just in America, but also now in recovering Europe--is what’s behind the upward pressure on prices of many commodities, Genetski says.
Moreover, Jim Grant of Grant’s Interest Rate Observer newsletter in New York has in recent months catalogued how depleted stocks of many raw materials have become over the past few years, as industrial and agricultural capacity has been slashed. Coffee is one example; and in grains, “Ratios of stocks (inventories) to usage stand at a severely low ebb” globally, Grant says.
The inventory problem is key, because it is the rebuttal to the argument that increasing global competition will suppress commodity price hikes. Unfortunately, competition can’t occur overnight in many depleted markets, Grant warns.
Even though raw materials account for just one-third of manufacturing costs (labor is two-thirds), Genetski sees enough of a push in commodities to lift annual inflation, now about 3%, to 5% in ’95 and 6% in ’96. There could be winners in the stock market under that scenario (see box below), but the bond market would be a goner.
Commodity Plays
Stocks of companies tied to commodity industries, such as chemicals, energy and metals, have generally performed better than the broad market this year. A sampling:
52-week Tues. Pct. chng. Stock high/low close yr.-to-date Stone Container 16 7/8-6 1/2 15 1/4 +58% DuPont 61 3/4-44 1/2 61 1/2 +27 Dow Chemical 67 7/8-53 1/2 67 3/4 +19 Phelps Dodge 59 1/2-39 1/8 57 1/4 +17 Mobil 84 3/4-69 82 1/4 +4 Reynolds Metals 54 5/8-40 3/8 46 1/8 +2 Unocal 32 3/8-24 3/8 28 1/8 +1 Inco 28 1/2-17 3/8 26 7/8 nil Alcoa 82-64 1/4 69 5/8 nil Georgia-Pacific 77 1/4-56 3/8 63 7/8 -7 Bethlehem Steel 24 1/4-12 7/8 18 1/8 -11 S&P; 500 482-439 455 -3
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