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Looking for Good News on Inflation

Posted by: Ben Steverman on June 4, 2008

Earlier this week, I wrote about the threat that inflation poses to investors. To hedge against inflation, many investors are plowing their money into commodity funds, and thus betting on the very trend — record food and energy prices — that is causing the inflation.

Inflation worries would ease — and commodity investors would be punished — if there were signs of so-called “demand destruction”: If demand for fuel, food and other commodities slowed, prices would fall.

A global recession is one way to dampen demand (thanks but no thanks) but in a best case scenario, people and companies would adapt in a more graceful way. Will this happen?

Experts differed. “People don’t adjust their driving habits or eating habits that quickly,” said John Merrill, chief investment officer at Tanglewood Capital Management. Americans aren’t all going to go out and buy fuel-efficient cars right away, after all. Plus, he added, it’s hard, if not impossible, for emerging economies growing at almost 10% per year to cut their demand for resources.

But Doug Roberts of Channel Capital Research sounded more optimistic. People are gradually making changes large and small in their lifestyles: There are new sources of fuel and more fuel-efficient engines; people are changing travel plans. “It reaches an inflection point,” he told me. “Eventually they do adjust.”

As oil hit a record of $135 per barrel, Merrill’s pessimism seemed warranted. Recently, data has given Roberts’ view a bit of support, and oil prices have backed off $13. The U.S. Department of Energy said Wednesday that U.S. fuel demand fell 3% in the past year. Demand for gasoline is down 1.4%, while jet fuel demand fell 3.5%.

In response, this is what Marc Chandler of Brown Brothers Harriman wrote today:

America is responding to the dramatic price increase in oil and related
products. They are driving less. They are buying fewer SUVs and cars in
general and the cars that are being bought appear to be those that have smaller
engines and get greater fuel efficiency. They are using less oil.

But is falling demand in the U.S. enough to make up for rising demand in emerging economies? (There’s some good news on this, too: There are signs some governments are reducing fuel subsidies.) It would also help inflation-fighters if producers of oil and other commodities could find ways to increase supply.

Reader Comments


September 9, 2008 4:31 PM

"Demand destruction" has it's limits. Commodities speculators still believe that the primary bull market has years to go. We have seen a decrease as of late in oil prices, but it's merely another in a series of corrections. Long-term commodity investors will be just fine regardless and sometimes in spite of inflation.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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