Commodity Inflation Is Coming

Trend: Commodity prices are moving up as producers are unable to ramp up production.

Source: MSN Money - Stocks for the 2006 commodities crunch - Jubak's Journal

...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 where the core rate climbed by 0.2% instead of the 0.1% monthly increases of April through September.

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.

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.