The Reversal Is Coming

almost 3 years ago

Remember when Lumber was the poster child for the inflationists argument for massive inflation. We were warned that hyper-inflation is coming.

It seems that the likes of Peter Schiff and Jim Rickards were wrong once again.

While the commodity did have a massive run up, it has collapsed the past 45 days. It is amazing how much can change in a couple of months. Keep this in mind when looking at the situation going forward.

The price of Lumber peaked at just shy $1,700 and now is under $500. That is more than a 70% drop.

Obviously, one commodity does not tell the entire story. However, when it is put up as the epitome of inflation, when it reverse, isn't that deflationary?

To further the situation with Lumber, we are seeing the prices moving back into range they were before. Looking at a long chart, we see that the price is now below the high in 2018, which was the previous all-time high before this recent run.

Oil As A Barometer

Another commodity that went on a run and is creating a great deal of chaos is oil. We are seeing a heated situation within OPEC as whether to pump more oil or not. Either way, the global prices are on the upswing.

The challenge with this commodity is that oil affects everything. We see it add to transportation costs of food and other products. It goes into our plastics as well as an assortment of fuels.

When we see large runups in oil, there is a threat to the global economy. In this situation, we are looking at weakness to start with. Having high oil prices for a sustained period will only further the economic weakness.

Nevertheless, the run does not appear without resistance.

This week we saw a pullback in oil prices. What is notable about this is the fact that the $75 level has served as a barrier in the past. We last reached these levels in 2018 only to have them rejected. There is a chance that we see the situation repeat itself.

We see the move higher based upon the idea that demand is on the rise. Since the lows during the lockdown, that is true. However, when we look at things in regards to overall consumption, this is a hard case to make. Looking at the traffic patterns of major cities as well as commercial real estate occupancy, it is evident that people simply are not commuting like in the past.

Consumer Price Index

This week, we got the print on the CPI for the United States. It was awful setting a number not seen since the Great Recession.

Of course, this is what all those beating the inflation drum are pointing to.

Source

The challenge with this is that, as the Fed stated, this is a lagging indicator of economic activity. This typically means rough times are head. So we can expect the next 12-18 months to see pullbacks from the level of economic progress that is being made.

As is the case with oil, we can expect this to reverse course starting in the next month or two. When it reverses, we can expect it to be fierce.

Cheap Goods

The other point that is overlooked is the fact the global economy was shut down meaning that products were not shipped. This kept low cost producers from being able to move their wares for much of 2020. Even now, we are still dealing with a container shortage meaning products are not moving at the pace they could.

What this allowed was for high cost producers to hold their prices up. Without the foreign competition, margins were held and profits were realized. This is not going to carry on forever.

The shipping of global products is already underway. For the next quarter or so, we could see prices remain high as these producers re-enter the market. When they do, the incumbents who gained market share, are going to have to get competitive with their pricing.

With the reopening of supply chains, we are going to see the deflation from countries like China and Vietnam exported to the developed countries.

Economic Slowdown

The banking system is awash with cash. So is the financial system. The problem with this is the money is not making it into the general economy. Without enough cash to in the system, higher prices get rejected. They simply cannot be sustained.

In a week and a half, we get the Velocity of Money reading for the last quarter. This will be very telling as to what the economy is doing.

Unlike many other economic indicators, the VoM has not rebounded. While there was a bounce back from the second quarter, the last two saw negative readings. In other words, the pace which money is flowing through the system is slowing down.

This is not an inflationary characteristic. Economies cannot expand a great deal when the VoM is slowing down, especially since we are already at historic lows.

We are likely to see another negative reading simply due to the fact that there is so much cash locked in the banking system. This is compounded by the fact that lending is tightening, as evidenced by Wells Fargo's elimination of credit lines earlier this week.

For all these reasons, do not buy what the mainstream media is selling. We are not seeing an economic expansion nor is inflation going to be a problem going forward. Instead, we are going to see more weakness in the months ahead. This simply cannot be avoided. All the indicators are telling us that we could be in for a sub 2% growth rate by the end of 2022.

Companies will have to enjoy this economic thrust forward. It will not last long for most of them.

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