Gold’s Advance Contradicts Slide in Other Materials

The price of gold has jumped to a 2 1/2-year high in recent weeks, and that kind of move naturally gets attention on Wall Street because of the metal’s historical role as a “messenger” of sorts. But what, exactly, is gold saying this time? That inflation is coming back?

You wouldn’t guess that that’s the message if you look at what’s happening with cheaper metals, or with industrial commodities in general. The trend of prices is definitely down.

While gold edges up, the cost of copper, aluminum, zinc, nickel and other key metals has been declining over the last year, in some cases sharply. Goldman Sachs’ index of industrial metals, for example, is down 16% from a year ago.

Another commodity gauge, the Commodity Research Bureau index of raw industrial materials prices, has been plunging in recent months, which economist Edward Yardeni of Deutsche Morgan Grenfell/C.J. Lawrence in New York contends “is a sign that recessionary forces are building not only in the U.S., but also in other major industrialized countries.”

If industrial commodity prices are falling, after all, it would seem to suggest that demand for those materials from manufacturers also is falling. And manufacturers would only opt to produce fewer finished goods because their customers--either at the wholesale or retail level--are buying less.

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Indeed, several major commodity-producing companies reported fourth-quarter earnings on Tuesday, and warned that the pricing outlook isn’t improving. Paper and lumber giant Weyerhaeuser said that demand for pulp and paper products “weakened in the fourth quarter for the first time in two years,” and that “it appears that this weakness is likely to persist into 1996 as customers continue to reduce their inventories.”

Borden Chemical and Plastics, a producer of PVC resins used to make plastics, said PVC prices “eroded during the fourth quarter as a result of a soft export market, ample product supply and historic seasonal weakness.”

Of course, commodity markets are notoriously volatile. Gordon Richards, economist at the National Assn. of Manufacturers, says the “signal-to-noise ratio in commodity prices is extremely low” in the short run--meaning one ought not to read too much into short-term moves.

Still, Richards adds, the idea that slackening demand is forcing commodity costs lower “would be consistent with what we know is going on with the economy.” Activity is slowing, Richards says, and it’s slowing enough to warrant another cut in interest rates when the Federal Reserve Board meets Jan. 30, he argues. The decline in commodity prices is another warning sign that “we should be concerned about the implications if the Fed doesn’t cut rates” further, Richards says.

Falling commodity prices also would seem to signal something else: that the threat of higher inflation any time soon is waning. If raw materials prices are falling, that is at the very least non-inflationary, and could even be deflationary as far as prices of some finished goods are concerned.

But then, what is gold--the traditional inflation hedge--telling us as it hovers above $400 an ounce for the first time since late-summer 1993? Where is the inflation threat? “That’s what I’m wondering,” admits John Lonski, economist at Moody’s Investors Service in New York.

Maybe gold is reflecting some investors’ jitters over the budget follies in Washington and the growing threat of a politically forced U.S. Treasury default. Or perhaps gold’s latest gain is nothing more than a temporary supply-demand problem tilted in favor of the suppliers.

Some economists, however, worry that gold sees nascent inflation where many experts aren’t looking: in future wage increases. Robert Brusca, economist at Nikko Securities in New York, notes that the strong consensus belief is that nobody in America can get a raise. Yet U.S. unemployment remains historically low, he says, and the pace of increase in hourly earnings has already crept up from a 2.5% average annualized rate in mid-1994 to just over 3% at the end of 1995.

What if the surprise of 1996, Brusca asks, is that wages rise more than expected despite a slow economy and lower commodities? With labor accounting for most of businesses’ costs, he notes that inflationary pressures are much more a function of wage gains than of zinc or lead prices.

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Commodity Bust?

Gold prices are up, but the Goldman Sachs index of key industrial metals has slumped from its peak last January--a sign of a weak economy. Monthly closes and latest:

Tuesday: 623.66

Source: Bloomberg Business News