The surge in construction materials prices accelerated in May with the index jumping 2.6% from April. The index is now 8.4% higher than a year ago. Energy based product and metals prices moved markedly higher in the survey that will yield the June which has just been completed so another price rise on the same scale is anticipated for June. The cost index is likely to increase at a double-digit annual rate -0.8%.month or more — through the summer. Then the price index is expected to stall, possibly decline a little, at the end of 2008 and in early 2009.

This is exactly what happened in 2004-05. The earlier surge in inflation ended when suppliers eventually caught up with the rapid rise in commodity demand that began late in 2003. The current inflation surge is more likely to end when high prices in a weakening world economy cause a drop in demand.

This process is already beginning. China has announced reduced subsidies for energy products. Other countries will do the same to prevent an unbearably large government budget deficit. Separately, there is evidence that worldwide business investment, the key source of added demand for metals, has stopped growing due to rapidly rising inflation.

US contractors are caught between declining demand as new project starts slow and soaring costs, largely due to events outside the US.

The largest May increases were for structural steel (10.7%), diesel fuel (9.1%), softwood lumber (7.1%) and steel pipe (7.5%). Buyers of gypsum, aluminum and ceramic tile enjoyed prices cuts from April.

Generally, prices of products prices in US domestic market are steady or falling slightly while pieces set in world market are rising rapidly due to the declining dollar and the new dominance of Asian buyers in world commodity markets.

Steel
The huge jump in steel prices is not yet over. Iron ore suppliers and steel mills have announced higher prices that are not yet in the price index. As in 2004, this price surge began when steel inventories were unusually low. This is another inventory cycle. It is now nearing its end. There will be periods in the next few years, as there were in 2005-06 when steel prices are slightly below the peak in the inventory cycle.

Oil
The market dynamics for crude oil are different. The recent price doubling began when inventories were near normal. This is not an inventory cycle. We have experienced a real and sustainable rise in demand at the same time that rebellions in the oil fields worldwide have restrained supplies. In the last few days, Nigerian rebels attacked and temporarily shut down a 200,000 barrel/day oilfield 50 miles offshore.

Rising demand and at best steady supplies have pushed inventories below normal operating levels resulting in the ongoing price surge which has turned into a bubble as investors flooded into the oil futures markets. Like any bubble it will pop soon when speculative activity sufficiently reduces the demand for oil. This process is underway.

So far the US has had to bear almost the full burden of adjusting demand to the new higher prices because much of the world’s oil is sold at government subsidized prices and the rest of the world has enjoyed a huge price discount as their currencies appreciated against the $US. The $US has recently steadied and cash strapped governments will soon cut subsidies and raise energy prices, as much as 50% in some cases.

This explains the consensus outlook that crude oil prices will be sliding lower within a few months.

Construction Materials Inflation – May 2008

Source: Producer Price Index, Bureau of Labor Statistics,
US Department of Labor, Federal Reserve Board, Census Bureau

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