No doubt about it. Trying to estimate what will happen with respect to construction material costs is a tricky business. One can come at the issue from several directions. A good starting point is commodity prices. Commodities form the cornerstone for all building products.

The China effect

A number of commodities have touched bottom in their cycle and are now moving upward.  Several factors have contributed to the turnaround. China and Southeast Asia have played significant roles. Chinese stimulus spending got the ball rolling. Stockpiling by China’s government and its industrial concerns has also been a factor. This has been enabled by huge foreign currency reserves that were built up earlier from manufactured goods exports.

This was a first wave of Chinese raw material purchases. It is likely to die down again for a while. There is a limit to the amount of money the Chinese government will pump out. What is needed is a revival in China’s trade with other nations, especially the West, and/or a surge in consumer spending within the country. To a degree, this is happening. Monthly car sales in China now exceed the U.S. This can only mean extraordinary demands for oil. Both China and the U.S. import more than half of their oil requirements. China is building immense tank farms.

Commodities as an asset class

In the West, speculation and purchases by investment firms and hedge funds is increasingly playing a role in commodity prices. It happened in the last boom. On the flip side, it was a cause of the commodity price collapse in the latter part of last year. Anxiety about the very survival of the world financial system caused a retreat out of commodity holdings and into U.S. dollars. The greenback was seen as a “haven of last resort.” Now that anxiety about the world banking system has eased, investors and speculators are turning again to other assets with higher potential returns. Equities and commodities are at the top of the list, well ahead of real estate at this time.

Not all anxieties have been put aside, however. Some commodities, such as gold and silver, see action when there is worry about inflation or theatres of conflict around the world. The greater the geopolitical uncertainty, the more gold comes into demand. But at this time, the price of gold is on the march for a different reason. The global recovery stage is different than in the past because there is real concern about the value of the U.S. dollar. Washington’s spending excesses, whether justified or not, are leading many to conclude that the greenback is on a downhill course.

Currency effect and transportation costs

A falling U.S. dollar has special significance for commodity producers. Almost all commodities are priced in greenbacks. If the dollar slides, the only way to maintain real currency-adjusted returns is to increase prices. That can only be achieved if one has a degree of control over supply. No wonder there is media speculation and increasing talk that Middle East nations might like to see the price of oil tied to a basket of currencies rather than just the U.S. dollar.

As the price of oil moves up, this will have an impact on shipping costs. For the moment, the Baltic Dry Index – a measure of the cost of moving cargo on ocean-going freighters – is still near the bottom of its range. There are apparently vast tanker fleets lying empty at major shipping ports. This is a pocket of excess capacity in the supply chain that will gradually diminish as economies around the world climb out of their foxholes. The same goes for inordinate levels of inventories in many of the raw material categories. Few recent investments to bring on greater production will eventually lead to a problem in supplying base metal demands, for example.

Demand/supply factors and stage of cycle

Another major factor determining some commodity prices is the demand-supply equation for main usages. For example, lumber prices are on the move, albeit to only a minor degree so far, because U.S. homebuilding has stabilized at a bottom level. Further mortgage foreclosures are still in the offing as various government rescue packages expire, but both starts and prices are not likely to decline any further. U.S. monthly starts annualized have lately been sticky at between 550,000 and 600,000 units. In Canada, starts have apparently reached a support level of about 150,000 units. The reasons are exceptional enthusiasm in resale markets, very low interest rates, improving consumer confidence, some bargain home prices and a limited number of listings.

As for other construction-related commodities – copper, nickel, aluminum, steel, concrete – non-residential building construction will continue to lie low well into next year. This is a result of underutilized capacity in office buildings and on the shop floor. Beyond the mid-point of next year, the trend will shift into a higher gear as private sources become freer with their investment spending. In the engineering/civil field, government stimulus money still has a lot of legs left.