Home Commodities Commodity Prices Are Leading Indicator Of Inflation’s Demise

Commodity Prices Are Leading Indicator Of Inflation’s Demise


Prices of bellwether commodities like oil, gas, lumber and copper are down significantly from a year ago.

Commodity markets are remarkably efficient in a classic “Econ 101” sort of way. Prices go up, producers respond with higher rates of production, and then prices go down. A look back at recent history makes it easy to see why commodities are famous for their cyclicality.

Prior to the onset of the COVID pandemic, the global economy was stable, relatively healthy, and, most importantly, the supply and demand of most commodities was largely in balance. Rates of consumption were steady, and commodity producers were, by and large, fulfilling demand requirements through efficient and well planned production increases. Things were predictable; demand rose incrementally and steadily, and money was cheap for investment into production facilities. Producers could pretty much predict how much they needed to produce and how to expand their production over time just enough to keep pace with demand. In addition, the global flow of goods was operating smoothly with most things on a just-in-time delivery schedule due to efficient economic globalization. Business was good.

Then COVID delivered a devastating one-two punch sequence that completely upended the halcyon days of relatively balanced supply and demand in the commodity markets.

First, movement and work restrictions seemed to instantaneously destroy demand for most core commodities. In many cases producers were forced to quickly cut production due to a heavy reliance on globalization and just-in-time point of production to point of use delivery. There was simply nowhere to store excess production for which there was diminished demand.

Second, demand for commodities surged when the COVID reopening combined with massive direct (straight to consumers) government stimulus created unprecedented spikes in demand for nearly all commodities. Prices of everything exploded higher. Commodity prices led the way when producers couldn’t keep up with demand because both their production and delivery operations were disrupted. Prices of everything commodity related rose rapidly with commodity prices, leading the way to our current higher than usual inflationary environment.

The price of everything else rose with commodities because of direct-to-consumer-bank account deposits by the government, resulting in the classic “too much money chasing too few goods” scenario.

Now, commodities are leading the way downward. The initial imbalance caused by the post-COVID demand surge pushed commodity prices quickly to the spike price highs set over a year ago, but pent up demand isn’t steady demand, it’s only temporary. Once the initial demand surge was satisfied, commodity prices began to fall rapidly, but prices stayed higher than usual because markets still had to readjust to a post-globalized world in which just-in-time production-to-use logistics were no longer operating like they did in the pre-COVID, pre-Black Sea war era. That took some time, but commodity producers are practical, resilient, and very good at what they do.

It has taken the better part of a year, but now things in commodity land are much more stable, meaning producers are doing what they do best – producing. Production is beginning to outpace demand in many areas, and prices of most commodities are still experiencing steady declines. The big daddy of them all, crude oil, is sinking slowly but steadily lower, perhaps on its way toward the $50 mark. Natural gas is at multi-decade lows. Copper and lumber have declined dramatically off their price highs. Other commodities, with the exception of precious metals, are also experiencing year-on-year price declines.

All of this means that inflation is headed lower. Commodity prices are no longer a root cause of inflation, in fact, deflation is a better descriptor right now for most of the commodity world. Commodity producers responded to high prices with higher production, and prices headed lower. The other inflation ignitor, too much money chasing too few goods, can only be solved by government policy of some sort, which will likely take much more time than it took for commodity producers to do their part in the inflation fight.

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