Commodities Are Coming On

Stirrings of commodity pricees raise the specter of a more generalized shift in price trends.
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I wondered what was meant, in denotative and connotative senses, by the word "commodities," so I went to the scholarly

Palgrave Dictionary of Economics

to do a bit of research. But the item began with a long paragraph on the etymology of the word back through Old Frisian to Old Norse, so I figured, what the heck, let's wing it.

One specific quality of a commodity that pertains to the point I want to make is its undifferentiability from its competition. The hard winter wheat of Farmer Jones is no better than that of Farmer Smith; it matters not that Jones is really a great guy. "Parts is parts" is the deathless phrase from a TV ad for one purveyor's claim of superiority for his own offerings of chickens; by succeeding in "branding" his chickens, he elevated them from the nameless ranks of commodities. We can infer that they may have appreciated the implied honor but regretted its demand-enhancing effect.

Another quality of commodities, derived from the first, is that producers have virtually no ability to influence price. If Smith tries to extract a premium price for his wheat, we can buy the identical commodity from Jones instead, or from hundreds more just like him. As a result, the prices of commodities are set by the raw forces of supply and demand, and not by Madison Avenue or snob appeal or imperious designer's decree. The history of commodity prices reveals that the forces of supply and demand are seldom well balanced; one or the other always seems to have the upper hand, and so prices tend to rise or fall but rarely move sideways.

Raw commodity prices in general have been falling for quite some time now. It is important to keep track of the passage of time in markets, because adjustments to changes in prices take time and those adjustments can change the prevailing trend in prices. This is particularly true in commodity markets, where supply adjustments can be as powerful as demand adjustments in changing the trend. If the price of wheat is such that Jones can't recover his costs, he goes broke or otherwise stops producing. In the classic

Groucho Marx

routine, the straight man rolls his wrist and complains, "It hurts when I do this."

"Then don't do that," advises Dr. Groucho. And that's how supply adjustment works in a commodity market, in a nutshell.

Signs of Life

Whether due to a pickup in demand or to supply restraint, or to the passage of time, commodity prices are showing quite a bit of life this year. Crude oil futures have bested most Internet stocks, with a 50% year to date price appreciation. Crude has also pulled up the prices of gasoline, heating oil and natural gas. Aluminum and copper prices are lifting. Ditto for lumber. Most agricultural crop prices remain soft, as are live and feeder cattle prices, but lean hogs are frisky, figuratively speaking. Silver is strong, but gold remains inert, whatever metallurgists may say. (A huge overhanging supply of gold is held in what looks to be weakening hands: The world's central bankers are in live debate about the need to maintain reserves at their current levels and in their current form.

Alan Greenspan

, former gold bug, spoke last week at a

World Bank

conference on the subject. His remarks were skeptical in tone on the costs and effectiveness of maintaining large reserve balances.)

These stirrings of commodity prices raise the specter of a more generalized shift in price trends. If nameless faceless unbranded commodities indicate that power has shifted in the direction of sellers, then what are the implications for other markets? Not favorable for buyers, generally, although the opposite is the case in markets for financial assets -- which is a mixed blessing indeed.

Last week's neck-snapping reversal in the bond market is revealing. Recall that bond yields had backed up this year as the global economic outlook has righted itself. Commodity prices also have been affected by this change in prevailing outlook, but the price trends and the outlook are, as ever, subject to change; both are still tender and malleable. But last Thursday, when the first quarter

Employment Cost Index

printed as a jaw dropping 0.4%, well below the most bullish estimate, bond prices popped. They held most of that initial gain throughout the day's trading and added a bit to it overnight. But then, when the first quarter real GDP report showed that domestic final sales had actually accelerated to a 6.8% annual rate from the rip snorting 6% of the prior quarter, bonds gave back their gains and then proceeded to trade off sharply from there. In balancing the bullish ECI and the bearish domestic demand numbers, this forward-looking market seems to have had little trouble determining which has the wind at its back.

Bond yields are up, commodity prices are up, and cyclical stocks are making terrier-like assaults upon the favored few technology, healthcare, and financial names. Energy, basic materials, transportation, and consumer cyclicals are giving at least as good as they get as the volatile battle for hearts, minds, and portfolio share rages with a new intensity. Growth stocks won't yield gracefully and value stocks, this time, won't cut and run. As a result, the market is broadening out in an apparently healthy way, but the overvaluation concern looms still larger.

Bond and commodity markets can quickly re-evaluate their judgments on the power and persistence of the global economic recovery, but their reading for now is that world growth is coming back. A tightening of credit spreads and improvement in investment flows to emerging markets reinforces this conclusion while simultaneously helping the recovery along.

Meanwhile, shooting war in Europe reinforces economic factors to shore up the U.S. dollar against the euro. The value of the dollar is a key monitoring point: it has held up well in the face of a burgeoning trade gap as foreigners have been only too happy to accept financial claims on the U.S., whether they be debt or equity, private sector or public, operating or portfolio capital. But if that dollar-positive sentiment shifts, a vicious cycle might quickly be set in motion. And market action may then remind the Fed of its now dormant doctrine about the need to act preemptively.

The

Fed

, right now, by common consent, can do nothing. Growth is too strong, labor markets too tight, and stock prices too high for the FOMC's collective comfort, but inflation remains somnolent. But some of the recent stirrings in forward-looking markets bear watching. I can't muster the conviction to stand up and say the Fed will surprise a lot of people this year, but the circumstances won't permit me to sit down and forget about that concern. The pattern of price trends in stock, bond, commodity, and currency markets this year makes it difficult to draw any real comfort from unrealized capital gains.

Jim Griffin is the chief strategist at Aeltus Investment Management in Hartford, Conn. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Aeltus manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at

GriffinJ@aeltus.com.