Inflation -- as measured by the consumer price Index, anyway -- showed a huge drop in November. Driven by a 16% plunge in energy prices, this broad measure of inflation at the consumer level fell by 0.6% from October. That's the biggest monthly decline in inflation since 1949, and it reset the annual inflation rate to 3.5% from a 4.3% reading in October.

But before you break out the champagne, I suggest you take a look at the evidence that the global system for producing and delivering commodities is breaking down under the pressure of demand.

The world may indeed have plenty of oil, coal, copper, iron, nickel and other essential industrial commodities in the ground to meet current demand -- especially with the big incentives to production that current high prices provide. But there's increasing evidence that commodity industries are suffering from shortages in key materials, gear and personnel. And because of those shortages, they can't get the oil, coal, etc., out of the ground without substantially higher production costs.

And that argues that we're in for another round of commodity inflation in 2006 that will increasingly feed inflation for the economy in general. In November, the core CPI -- that's the CPI with the effects of food and energy prices stripped out -- climbed by 0.2%.

That doesn't seem like much, but November marked the second consecutive month when the core rate climbed by 0.2% instead of the 0.1% monthly increases of April through September. In January 2004, the core CPI hit a 40-year low at an annual rate of 1.1%. With the November number, the core CPI is showing annual inflation of 2.1%. That's still low, but you don't have to be chairman of the Federal Reserve to know which way the trend is headed.

If core inflation gets worrisome enough, the stock and bond markets can forget about the Federal Reserve moving to the sidelines after one or two more interest rate hikes in 2006. That wouldn't be so important except that the bullish case for stocks in 2006 hinges on an early end to the Fed's interest rate increases. If commodity inflation in 2006 leaks through into higher core CPI inflation, you can forget about that scenario for the Fed -- and forget about a good year in 2006 for stocks and bonds.

Burning Through Rubber

So what's all this hullabaloo about a shortage of tires?

On Dec. 14, Canadian Pacific Railway ( CP) said a major customer, Fording Canadian Coal Trust ( FDG), had forecast a drop in production due to a global shortage of tires for the heavy equipment that hauls coal. Fording lowered its projections for 2005 sales by about 4%, and for 2006 by 9% to 13%, from earlier Wall Street estimates.

The problem isn't limited to Fording, nor is it especially short term. Coal-mining companies operating on the other side of the U.S.-Canadian border in the Powder River Basin of northeast Wyoming, such as Arch Coal ( ACI) and Peabody Energy ( BTU), have reported similar tire shortages and warned of potential production problems.

With big manufacturers of these specialized tires, such as Goodyear Tire and Rubber ( GT) and Bridgestone, just now looking to expand their plants, the shortage could go on for a while -- through 2007, Goodyear has estimated.

Why the shortage? The U.S. military operations in Afghanistan and Iraq have added to demand, but the big culprit is the energy industry itself. Coal and copper mines, for example, are running at full speed. That increases the demand for tires as new equipment is added and as existing equipment is run for more hours.

One huge drain on the tire supply has been the rapid expansion of oil-sands operations. Turning oil sands into oil has become economically attractive with oil at $60 a barrel, but producing oil from oil sands is essentially a mining-and-cooking operation with large numbers of huge heavy-duty trucks required to move the sands from where they're mined to the plants that cook them into oil.

If it were just a question of tires, even of tires across a huge swath of the U.S.-Canada coal and oil-sands belt, I don't think this would be a big enough problem to bump up the core inflation rate in 2006. But it's not limited to this one problem.

Economics 101

A world away, a shortage of construction workers and engineers has led to rising costs and postponed projects in the booming commodities economies of Australia and New Zealand. Origin Energy has delayed a proposed gas facility in New Zealand because problems in finding skilled workers have doubled the estimated cost of the project.

In the Australian aluminum sector, Alcoa ( AA), its Australian partner Alumina ( AWC) and Rio Tinto ( RTP) have put plant expansions on hold until construction costs come down.

Shortages of rigs, equipment and engineers are roiling the global oil industry. Royal Dutch Shell ( RDS.A) recently announced that it would hike capital spending by nearly 27%, to $19 billion in 2006. The company certainly needs to increase capital spending to make up for the reserves that vanished off its books when the company corrected earlier faulty accounting, but CFO Peter Voser told Wall Street analysts that about 25% of the increase is a result of price increases in the cost of drilling rigs and other equipment because of shortages in those markets.

I know Royal Dutch Shell is drilling in some of the most difficult environments in the world, but the degree of price inflation is still stunning. On the Russian island of Sakhalin, where Shell has a 55% interest in a massive oil and gas project, the company has said that costs will climb to $20 billion, double earlier estimates.

All the delays in adding new supply (and the bottlenecks that instead are reducing supply in some instances) make meeting the very modest forecasts for growth in global commodities demand much more of a challenge than it seems. The Organization of Petroleum Exporting Countries forecasts 1.9% growth in global oil demand in 2006, and the International Energy Agency estimate of 2.2% growth isn't all that different.

Strains that are showing in the global commodities supply system say that meeting even that modest growth in demand with a matching increase in supply isn't by any means a sure thing next year. And that much of this new supply will come on line with substantially higher production costs.

This isn't rocket science but basic classical economics: When a system operates at the edge of full capacity, prices rise as unexpected glitches slow production here and there or require extraordinary efforts and extra costs to keep the system running. I think that's what we can expect in most global commodities markets in 2006.

Little in the Bargain Bin

How do you invest to take advantage of this kind of commodity inflation?

First, you buy the shares of the companies that are the beneficiaries of the shortages and the price increases. In a situation like this, the dollars flow to the companies that own the drilling rigs, that sell the pipes and connectors, that supply the mining equipment and that build the infrastructure.

I expect Nabors Industries ( NBR), Chicago Bridge and Iron ( CBI), Ensco International ( ESV), General Cable ( BGC) and Noble ( NE) will do well in 2006 as well. And I'll add Grant Prideco ( GRP) to this list. The company is a late-cycle play on increased oil and gas exploration and production.

Second, you should buy the shares of selected commodities producers when a company shows signs of being able to increase production at a time when the rest of its sector can't add capacity.

The problem is that very little on the producer side is a bargain. While investors got a decent opportunity to buy into the oil and gas sector when the whole group sold off in early October, I can't tell you when the next opportunity like that might arise.

The sector that interests me most as an investor is the U.S.-Canadian natural gas industry. Because it's tough to move natural gas to the U.S. (where it's in short supply) from overseas fields (where it is comparatively plentiful) due to a lack of liquefied natural gas terminals, U.S. prices will rise in 2006. But even here, I'll wait until warmer weather or some other short-term trend drives down prices in this volatile sector.

While you're waiting, I think it's still possible to find individual stocks that are relative bargains. One that comes to mind is Anglo American ( AAUK), which is in the process of selling off its gold, paper and steel businesses in order to focus on its core business of mining diamonds, platinum, coal, iron and base metals.

Even here, though, I'm going to wait until the end-of-the-year dust clears: It looks to me like we'll end the year with profit-taking, as momentum players who drove up stocks in November and early December sell to lock in their end-of-the-quarter numbers. Let's see if January brings a better entry point.

Get Jim Cramer's picks for 2006.

At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Chicago Bridge & Iron, EMC, Ensco International, General Cable, Nabors Industries, and Noble He does not own short positions in any stock mentioned in this column

Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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