In the world of higher commodity prices, corporate winners and losers fall into two distinct camps. Commodity producers are big beneficiaries, their business outlooks generally strong and their ratings stable, as scarcity and worldwide demand affect everything from corn to copper. But companies that rely heavily on grain, oil, or other commodities to make finished goods face increasing costs and thus weaker profits if the slowing U.S. economy makes raising prices more difficult.
The fallout from high commodity prices will be unequally distributed and determined by whether one is a buyer or seller of commodities. The level of commodity input into finished goods and the ability to raise prices will determine how serious the impact will be for commodity users.
Low steel costs, for instance, are certainly better than higher costs for automakers. But steel is a relatively small part of a car's cost, and the woes of Detroit's Big Three (oil prices and labor costs, for example) go far beyond steel prices. Baked goods, cereals, meat, poultry, eggs, and dairy products all contain, directly or indirectly, large amounts of corn or wheat, so the impact of higher prices for those grains is widely felt among food processors. And the high price of oil will clearly be deleterious for industries like refiners or airlines, where oil is a major input.
Meanwhile, the impact of rising commodity prices on U.S. consumers has been more straightforward. Prices for gas, home heating oil, and food have skyrocketed in the past year, boosting inflationary fears and crimping discretionary spending. Higher commodity prices don't account for all of the present economic slump (falling home prices and rising unemployment clearly play key roles), but they don't help, either. How high and how fast commodity prices rise will continue to be a worry for consumers and business alike this year.
The Speculation Factor
One of the most frequently voiced suspicions concerning commodity prices is whether they're being manipulated higher by speculators. There is no easy answer to this. Many commodity prices have risen for reasons clearly evident. Rising demand from India and China, for instance, has spurred on higher metal prices. The same can be said for oil, and a growing worldwide demand for food and for corn-based ethanol has boosted agricultural prices.
But the volatility of commodity prices leaves a deep suspicion in some corners of the financial community that it's not the traditional, commercial end-users of commodity futures contracts, options, and other derivatives that are responsible for pushing prices higher. An increasing number of hedge funds, pension funds, and other large investors are buying commodities in search of better returns than other investment vehicles—stocks, bonds, and real estate—are now providing. Trading volumes have increased greatly. The Futures Industry Assn. reports that 15.2 billion contracts were written in 2007, a 28% increase from the year before.
The other evidence for speculative forces is that some commodities seem priced far higher than fundamental supply and demand would indicate. We at Standard & Poor's believe, for example, that the price of oil, now north of $100 per barrel, will settle at roughly $91 by yearend. Over the longer term, we're expecting a price of $75, which is about 25% lower than it is today, as supplies remain adequate (although refining capacity remains a problem). Gold surged to more than $1,000 per ounce and then, in early March, saw the largest dollar price drop in almost 28 years on interest rate worries. Macroeconomic factors play a part, to be sure, but such volatility cannot always be attributed to big-picture economics.
To curb undue market volatility, several U.S. agricultural exchanges have already increased margin requirements (the amount of cash, as opposed to credit, required to buy a contract) on futures trading.