the Bears have no shares

By Rich Miller and Matthew Benjamin
June 8 (Bloomberg) -- As if General Motors Corp. didn’t have enough to worry about, a 60 percent jump in gasoline prices this year may cause inflation to soar as it did in 2008 and throw another roadblock in the way of recovery.

It’s “one thing that we have to keep our eye on,” said Mike DiGiovanni, executive director of global market and industry analysis for the automaker, which filed for bankruptcy last week.

It isn’t only GM’s sales that might suffer. Higher energy costs helped trigger a 20 percent rise in a Standard & Poor’s index of 24 commodities during May, the biggest monthly percentage gain since September 1990. The increases threaten a burst of inflation that could sap demand just as the U.S. economy is starting to right itself after the biggest contraction in five decades.

“You could end up with something like a stagflation scenario,” said David Hensley, director of global economic coordination for JPMorgan Chase & Co. in New York. “There’s a risk the economic recovery might be stifled.”
Gasoline was up to an average $2.59 a gallon nationwide last week from $2.05 on May 1, according to AAA. A 50-cent-a- gallon markup removes about $70 billion from consumers’ annual spending power, says James Hamilton, a professor of economics at the University of California, San Diego.

Prices still remain short of the $4.11 record set on July 15, which helped push inflation that month to a 5.6 percent annual rate, the highest in 17 years.

Fuel-Efficient Models
DiGiovanni told Wall Street analysts and reporters June 2 that Detroit-based GM was better positioned to deal with more expensive gasoline this year than last as it introduces several fuel-efficient models, including a Chevrolet Equinox sport utility vehicle that the company says will get 32 miles per gallon on the highway.

At United Technologies Corp., it’s copper that has gotten executives’ attention. The metal has climbed 59 percent this year on the New York Mercantile Exchange to $2.28 a pound as of June 5.

Gregory Hayes, senior vice president and chief financial officer, told a conference on May 14 that Hartford, Connecticut- based UTC is keeping tabs on price movements because its Otis elevator and Carrier air conditioner divisions buy 75 million to 80 million pounds of copper per year.

At that rate, the increase so far this year would cost UTC about $65 million, about triple Carrier’s $22 million operating income for the quarter ended March 31.

All-Time High
The metal is still down more than 40 percent from an all- time high of about $4 last year, and that’s “good news” for UTC, according to Hayes. “We’ll see where that goes,” he said.

The S&P GSCI Total Return index, which tracks metals and agricultural commodities as well as energy, has surged 39 percent since touching an almost seven-year low on Feb. 18.

Concerns about higher inflation are reflected in the widening difference between rates on 10-year notes and Treasury Inflation Protected Securities. The spread on June 5 was close to a nine-month high at 2.01 percentage points after the government reported payrolls declined in May by 345,000, the smallest decrease since September.

Spurring the commodity rally are signs of an economic recovery worldwide, particularly in China, the world’s biggest consumer of iron ore, rubber, copper and zinc; more interest from investors; and an 11 percent drop over the last three months in the dollar, the currency in which most commodities are priced. Stockpiling by China’s government and supply constraints have also played a role.

Stockpiling
China’s Ministry of Land and Resources in January announced plans to build emergency supplies of coal and metals to guard against potential shortages. The nation’s imports of Australian coal have soared more than 10-fold from a year ago.

Macarthur Coal Ltd., the world’s biggest exporter of pulverized coal used in steelmaking, is seeing new demand this year from China, said Shane Stephan, chief development officer in Brisbane, Australia. That is “a major change,” he adds. “We historically have never sold coal into China at all.”
If the advances in raw materials were being driven mainly by U.S. demand, there would be less worry that inflation might stymie growth. That’s not what’s happening this time. Economists surveyed by Bloomberg forecast the economy will contract at a 1.9 percent annual pace this quarter after shrinking 5.7 percent in the first three months of the year.

China, India Growth
What’s pushing up commodities instead is growth elsewhere in the world, particularly in Asia, Hamilton said. India’s economy grew at a 5.8 percent annual pace in the first quarter, topping economists’ projections of 5 percent. Chinese manufacturing picked up for the third straight month in May, according to a purchasing managers’ index published May 31.
Investors have also helped fuel the price surge. More than $6 billion has poured into commodity-industry funds so far this year, swelling assets under management by more than 21 percent, according to Cambridge, Massachusetts-based researcher EPFR Global, which tracks global fund flows. In all of 2008, new investment boosted assets by just 1 percent, EPFR figures show.

“Investors have been strongly attracted to commodity and energy plays this year,” said Brad Durham, managing director at EPFR.

Stagflation
Higher commodity costs are reminiscent of their climb in the 1970s and early 1980s, when a 10-fold jump in oil prices drove both unemployment and inflation above 10 percent. Economists coined the phrase “stagflation” to describe what was then a new phenomenon of accelerating inflation coupled with stagnant demand.

Hensley sees a risk of that happening to a lesser degree in the third quarter, as costlier gasoline lifts annualized inflation to 4 percent from 1.4 percent in the second quarter, depressing consumer demand in the process.
“This is unambiguously bad news for consumers, who are already feeling the squeeze from slowing wage gains and collapsing home prices,” said Ian Shepherdson, chief U.S. economist at Valhalla, New York-based High Frequency Economics.

Consumers’ sensitivity to gas prices is “extraordinarily high,” according to Richard Hastings, a consumer strategist at Global Hunter Securities LLC of Newport Beach, California.

“You don’t have to go back to record-high fuel prices to see damage to the economy,” he said.

Federal Reserve Chairman Ben S. Bernanke noted the rise in oil and other commodities in testimony to Congress on June 3, while saying excess capacity in the economy would keep a lid on inflation. U.S. factories, mines and utilities operated at a record-low 69.1 percent of capacity in April, according to Fed figures.

Capacity Constraints
The picture is different for some raw materials. Global oil production capacity use is about 95 percent, “and with the cutback in capital expenditures and drilling, future capacity is dropping,” according to a May 8 Goldman Sachs Group Inc. report. Production of copper is at 85 percent of capacity and corn and wheat are above 90 percent, the report said.

Soybean supplies are squeezed by drought in Argentina and tighter credit that curtailed plantings. Argentine farmers may harvest 32 million tons of the crop, down from a record 48 million tons last year, the Buenos Aires Cereals Exchange reported on June 3. Goldman Sachs says output in Brazil will fall as much as 10 percent this year. Soybeans on the Chicago Board of Trade have gained 22 percent in 2009 to $12.26 a bushel, the highest since September.

Corn, Wheat Supplies
The U.S. Department of Agriculture this week may reduce its projections of U.S. corn and wheat inventories before the 2010 harvests, according to average estimates in a Bloomberg News survey. Soybean supplies on Aug. 31 may fall to the smallest in five years on record export demand.
Not everyone is convinced that the rally in commodities, including oil, is sustainable.

Weaker demand “will eventually force those prices back down,” Jim O’Donnell, president of BMW of North America LLC in Woodcliff Lake, New Jersey, said in an interview. Commodities are in “an artificial market. I don’t think it’s real at this time. Worldwide demand is not there.”
Still, a growing number of companies aren’t taking any chances and are acting to protect themselves against higher costs. Emerson Electric Co., the St. Louis-based maker of industrial equipment and garbage disposals, hedges its risk from copper-price gyrations a year to 18 months ahead, according to Chief Executive Officer David Farr.

“We have seen more of our customers coming to hedge this quarter than the previous one,” said Craig Smyth, Citigroup Inc.’s Singapore-based vice president of commodities in Asia. “We have seen a two-fold increase in hedging.”