A hedge fund manager, back from a visit to Argentina, says he witnessed a Chinese delegation seeking to buy up all of the South American country’s excess production of flour.
A run on the global flour market? Well, after a year in which commodity prices surged with a rebounding world economy and a surging China most often cited as the reasons it may simply have been a sign of the times.
The Commodity Research Bureau’s futures price index rose about 8.9 percent in 2003, a second straight year of strong gains. Many components of the index, including oil and precious metals, have been on the rise.
Because the gains reflect an improved economic outlook for 2004, that is good news, not just for Argentine flour producers.
As the U.S. economy expands far more rapidly than most people expected six months ago, carrying along other export-dependent regions, prices of raw materials are rising, too. China, which supplies many of the finished goods that U.S. consumers snapped up during the Christmas shopping season, is also seeing domestic demand grow.
For investors like the hedge fund manager who visited Argentina, the rise in commodities has been a blessing. He said he had taken out an unusually large position in commodities normally considered a risky part of a portfolio as the new year approached.
But in addition to a recovering global economy, there are other causes and possible consequences of the surge in commodity prices, and some of those may provide cause for worry, analysts say.
Oil and gold prices, for instance, have been pushed higher by continuing worries about geopolitical risks, a euphemism for another massive terrorist attack. In times of uncertainty, gold is still seen as a haven. And oil prices rise when investors worry about supply disruptions in the Middle East.
The weakening dollar also contributes to gains in the prices of both oil and gold. Oil and gold are priced internationally in dollars, so a higher dollar price for them merely counterbalances some of the decline in the value of the currency.
It’s getting harder and harder to find analysts gutsy enough to predict a rebound in the dollar, so the early part of the year may well see further currency-driven gains in oil and gold prices.
But there was one odd feature of the rise in commodity prices last year: the relationship with bonds. Even as commodities have risen, bond yields, which move in the opposite direction from prices, remained largely flat.
That is unusual. Because commodities are seen as leading indicators of inflation, gains in their prices often are a sell signal in the inflation-sensitive bond market. Yet the 10-year U.S. Treasury note is yielding 4.38 percent, not much above its level of six months ago, when concerns about the U.S. economic recovery were rampant.
Yields on government bonds in other markets remain tame, too.
In 2003, inflation was not a threat, despite the gains in commodities. Until midyear, more analysts were talking about deflation, a sustained fall in price levels that erodes corporate profits. Even as U.S. economic growth recovered, the Federal Reserve and other central banks managed to keep a lid on bond yields by talking about maintaining interest rates at levels accommodative to growth for some time.
At some point in 2004, however, if the global recovery remains on its current track, central bankers will have to raise interest rates, most analysts agree. In Britain and Australia, they have already started.
So as the year kicks off, the relationship between commodities and bonds should provide a little bit of grist for worrywarts, who otherwise looked a bit sheepish as the economic outlook improved during 2003.
