Commodities Boom Signals Growth Wave for US Companies

Wednesday, 19 Jan 2011 03:38 PM

 

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U.S. investors should welcome, not fear, climbing commodity prices.

The increases are “largely a reflection of the fact that the pace of economic growth, particularly in the U.S., has picked up,” said Nariman Behravesh, chief economist at consultants IHS in Lexington, Massachusetts, and a former Federal Reserve official who has been covering the global economy for more than 35 years. “It’s not something to be worried about.”

The Standard & Poor’s GSCI Spot Index of 24 commodities has climbed 24 percent during the past year to its highest level since September 2008 as prices of raw materials from oil and copper to wheat and cotton have increased. That has prompted investor concerns that rising energy and other costs might derail the U.S. recovery by robbing consumers of purchasing power and pinching corporate profit margins.

History suggests they’re wrong to be concerned, said Michael Darda, chief economist for MKM Partners in Stamford, Conn. Commodity prices usually move in tandem with U.S. production, income and the stock market, so the increase is a reason to be bullish, not bearish, about the outlook, he said.

“High commodity prices are the result of rising demand, not the cause of future economic weakness,” Darda said. “Over the last decade, commodity prices and the U.S. stock market have usually moved together.” He sees the Standard & Poor’s 500 Index rising to 1,425 this year from 1,295.02 at 4 p.m. in New York yesterday as the economy grows by about 4 percent. The U.S. expanded 2.9 percent in 2010, according to the median estimate of 70 economists surveyed by Bloomberg News from Jan. 3 to Jan. 11.

Slowing Growth

Growth worldwide will slow to 4.3 percent this year after rising 4.8 percent in 2010, according to a team of JPMorgan Chase & Co. economists led by Bruce Kasman. China — the world’s biggest consumer of iron ore, rubber, copper and zinc — will again be the fastest-growing major economy, with gross domestic product forecast by JPMorgan to climb 9.1 percent in 2011.

Increasing demand for raw materials has caused the Journal of Commerce Industrial Commodity Price Index, which includes zinc and rubber, to jump 22 percent in the past year through Jan. 14, topping the highs it reached in 2008 before the September bankruptcy of Lehman Brothers Holdings Inc.

U.S. companies in aggregate aren’t as affected by the rising prices because they spend far more on wages and worker benefits than they do on commodities, said Zach Pandl, an economist at Nomura Securities International in New York. And their labor costs have been held in check by high unemployment, which has stalled above 9 percent since May 2009.

Rising Compensation

Employee compensation accounts for about two-thirds of the cost of doing business at nonfinancial U.S. corporations, according to data from the Commerce Department in Washington. Such compensation at private companies rose 2 percent in the third quarter of 2010 from the same period a year earlier, separate statistics from the Labor Department showed. That compares with an average 3.1 percent annual increase since the department began compiling the data in 2001.

Companies also can offset rising raw-material prices by increasing worker productivity and cutting other costs, Pandl said. That’s the case at ITT Corp., the White Plains, New York- based maker of military radios and submersible pumps. The company on Dec. 17 forecast that earnings per share will grow between 7 percent and 12 percent in 2011 on a “significant” rise in profit margins.

“Our expanded productivity initiatives are expected to more than offset increases in commodity prices and wages,” Denise Ramos, chief financial officer, told analysts in a conference call that same day.

Surging Shares

The company’s shares surged 17 percent to $61.50 on Jan. 12 after ITT announced it has decided to divide itself into three businesses, spinning off its water and defense units while focusing the reconfigured company on specialized products for industries such as oil and gas. ITT stood at $59.03 at 4:15 p.m. in New York on Jan. 18.

Corporations also are acting to protect themselves against rising commodity costs by locking in prices through hedges and other buying strategies.

“We are a little bit more hedged going into 2011 at this juncture than we typically have been in the past several years,” William Douglas, chief financial officer at Atlanta-based bottler Coca-Cola Enterprises Inc., told analysts in a conference call on Dec. 17. “We’ve got about two-thirds of our commodity-input cost hedged.”

Highest Profit

U.S. commodity producers benefit directly from the rise in prices. Alcoa Inc., the largest U.S. aluminum company, reported on Jan. 10 its highest profit in nine quarters after the price of the metal approached pre-recession levels. The New York-based business said net income totaled $258 million, or 24 cents a share, in the final three months of 2010, compared with a net loss of $277 million, or 28 cents a share, a year earlier.

The SPDR Metals and Mining Exchange Traded Fund, which includes Alcoa and 25 other companies, has outperformed the Standard & Poor’s 500 ETF Trust, climbing 53 percent since June 30, 2010, compared with 26 percent for the trust.

Stocks of oil companies also are up as the price of crude has risen about 21 percent since the middle of last year. Houston-based Marathon Oil Corp. has increased 37 percent, and Exxon Mobil Corp. in Irving, Texas, rose 38 percent. Fadel Gheit, an oil and gas analyst at Oppenheimer & Co. in New York, raised his recommendation on Exxon to outperform from perform Jan. 6, saying higher crude oil prices allow it to accelerate a stock-buyback program, increase its dividend and further reduce debt.

Exceeding Forecasts

U.S. agricultural companies also are benefiting from rising prices. Monsanto Co., the world’s largest seed company, posted higher first-quarter profit than analysts estimated on rising sales. The St. Louis-based company said Jan. 6 that earnings excluding restructuring costs were 2 cents a share in the three months ended Nov. 30, topping the 1 cent average of 14 analysts in a Bloomberg survey.

The Iowa Farm Bureau Federation in West Des Moines called last September for an end to direct federal government payments to farmers and suggested that some of the money instead be directed toward the promotion of trade. The American Farm Bureau Federation, the Washington-based umbrella organization that includes the group from Iowa, declined this month to support that position.

The run-up in commodity prices would be worrying if it were the result of a disruption to supply, rather than a response to increased demand, Behravesh said. That’s what happened in 1973, when the U.S. economy plunged into recession after Arab oil producers cut production to punish the West for its support of Israel in the Yom Kippur war.

No Shortfall

That’s not the case now, he said. Rising demand is driving prices, not a shortfall of supply. Consumer spending is strengthening: Sales rose at an annualized rate of 14 percent in the fourth quarter, the highest three-month run rate since 2001, according to Bloomberg calculations based on Commerce Department data.

Households have the wherewithal to withstand higher gasoline prices because they don’t devote that much of their money to energy purchases, Behravesh said. Consumers spent just 5.1 percent of their disposable income on these products and services in the third quarter, Commerce figures show. The national average price for unleaded gasoline at the pump was $3.100 a gallon on Jan. 17, compared with $2.746 a year earlier, according to Heathrow, Florida-based AAA, the nation’s largest motoring organization.

Future Expectations

While consumers’ overall confidence slipped in early January in response to rising gasoline prices, their expectations for the future rose, according to a Thomson Reuters/University of Michigan survey. The index of consumer expectations for six months from now, which more closely projects the direction of spending, increased to 68.2, the highest since June 2010, from 67.5 in December. For the first time in more than six years, more consumers expect unemployment to fall than to rise in the coming year, the survey found.

“Last quarter, the economy grew close to 4 percent,” Behravesh said. “This quarter it will probably do about the same.”

© Copyright 2014 Bloomberg News. All rights reserved.

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