As we head into mid 2021, commodity prices shows no signs of slowing down. Some say this is a warning sign of oncoming inflation.
Intuitively, this could be interpreted as an indicator inflation.
But commodity prices and consumer price inflation (CPI) are actually a lot less correlated than what most people may think.
The two were more correlated in the 1960s when developed economies relied more on manufacturing.
But now, if anything, the two are slightly negative correlated.
This is because consumers do not buy commodities directly. They buy finished, manufactured products.
And for many products, commodities only constitute a small portion of its manufacturing cost.
For example, steel prices only reflects about 3% of the final price of a car. Manufacturers typically absorb the volatility of commodity prices – benefiting when they fall and eating into margins when they rise.
This is why commodity prices are much more volatile than CPI.
Put simply, the importance of physical commodities in the cost structure has greatly diminished.
Commodity prices, however, do signal changes in global supply and demand. For prices to continue rising, it must be sustained by the demand the prices anticipate.
Does this mean that we should dismiss the inflation narrative?
Not necessarily.
All we’re saying here is the spike in commodity prices isn’t the most valid indicator of it.
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