Commodities: The Squeeze Gets Tighter

Prices for oil, metals, and grains are surging, putting businesses and consumers in a bind. And there's little chance of relief anytime soon

by David Bogoslaw

Investors, worried about the shaky state of the equity, credit, and housing markets—and the steady decline in the U.S. dollar—are seeking safety in hard assets. And that is driving prices of commodities ranging from precious metals to grains through the roof. Speculators may be sporting ear-to-ear grins, but the surge is causing consternation among businesses as they watch prices for key manufacturing inputs reach uncomfortable levels.

The price spikes have occurred across the commodities spectrum, with oil, which hit a record closing high of $104.46 per barrel on Mar. 5, the most visible example. But perhaps the most startling action has been in the precious metals markets, as traders hold their breath for gold to break the $1,000-an-ounce barrier (it reached a record $988.50 in futures trading on the New York Mercantile Exchange (NMX) Mar. 5, having risen from $775 last October). But other metals—ones with far wider industrial applications than the yellow metal—have seen similarly impressive run-ups. Aluminum prices have climbed more than 22% since mid-October, to $138.25 a pound, while platinum has soared 53.5%, to $2,267 an ounce over the past four and a half months.

And the ethanol-fueled boom for agricultural commodities has also been an eye-opener. Over the past four and a half months, wheat prices have risen 30.6%, corn prices have increased 47%, and coffee prices have climbed 15%.

A Harbor for Investors

The explanation is simple: Commodities have become the asset class of choice, a safe harbor in which to wait out what could be an extended bear market for stocks and fixed-income assets, depending on what happens with interest rates. Just take a look at the moves in the major commodity indexes: The Reuters-Commodity Research Bureau (CRB) index spiked 2% on Mar. 5 thanks to a fresh jump in energy prices. The index has set a number of all-time highs in recent weeks. In the past year, the index has gained just under 40%, with the precious metals sub-index of the CRB up nearly 62% and grains up 77.7% over that same period.

The basket of oil, natural gas, precious metals, grains, livestock, and other goods represented by the Dow-Jones-AIG Commodities Index closed at $213.86 on Mar. 4—up 15% since the beginning of this year and up almost 21% since stock indexes peaked in mid-October.

The CRB told BusinessWeek.com that it believes fears of inflation are encouraging investors to buy commodity futures. Those fears will probably persist as long as the Federal Reserve keeps easing monetary policy. The Fed's lowering of interest rates is also driving the U.S. dollar to new lows, which in turn fuels higher prices for real assets such as commodities, Gary Kamen, director of sales and marketing at CRB, wrote in an e-mail message.

A weaker dollar and upward pressure on commodity prices will last until the U.S. housing sector and the overall economy show signs of stabilizing, Kamen said.

For manufacturers, the effect of rising commodity prices from the mines to the fields is to push up input costs across the board. That leaves them little choice but to raise product prices or settle for lower profit margins. The headline producer price index for crude goods, which includes volatile energy and food costs, surged 2.5% in January. Food prices rose 1.7% in January and are up 8.3% from a year ago. Companies that are mired in a sales slowdown have to just suck up the cost increases.

Autos: Going Palladium

The surge in platinum provides a good illustration, Rising platinum prices have continued to vex auto makers—who use the metal in the catalytic converters that remove sulfur and other pollutants from fuel emissions—despite the progress they have made in substituting cheaper metals, such as palladium, for it. The strength in platinum prices for most of the last decade has stemmed from supply constraints and rising demand from the automotive and jewelry markets.

U.S. automakers have an edge on their European competitors in that gasoline-powered cars can use a cheaper metal, palladium, in their autocatalysts, where diesel vehicles, which now account for over half of the European car market, can't swap in palladium due to durability and performance issues.

But the growing reliance on palladium in U.S. cars has driven its price up as well. Palladium is now trading at $570.45 an ounce, up 47% since the middle of October.

"A lot of the [U.S.] carmakers are well into their [substitution] programs. They may be 90% to 95% on their way," estimates Tim Murray, the head of U.S. business for Johnson Matthey (JMAT), one of the world's largest manufacturers and refiners of precious metals, whose customers include car manufacturers.