Michael Pascoe writes:


It’s always dangerous to make too
much of any one set of statistics. But figures released overnight in
the US are pointing to a further surge in commodity prices – good news
for the Australian economy in the short term, but something that will
push central banks a little closer to using their blunt instrument.

On
the surface, the October US durable goods numbers aren’t very exciting
– take out lumpy aircraft orders and there was a gain of just 0.3%
after a fall of 0.2% the previous month. Ho-hum. Wall Street was more
interested in US new homes sales surging 13% to a record 1.42 million
units and a bounce in consumer confidence as petrol prices cooled.

But
Macquarie Securities’ international economist Mark Tierney has found
strong indicators for another wave of commodities demand tucked away in
the durable goods details. Shipments jumped 1.4% while inventories
gained just 0.4%, meaning the inventory/shipment ratio is extremely
low. Excluding aircraft, non-defence capital goods shipments increased
by a strong 1.9%, indicating another quarter of positive business
investment. And, perhaps most importantly, unfilled orders increased by
1.5%, reaching a new high point.

Writes Tierney to clients this morning:

When these three factors are put together, the outlook for
US manufacturing production is extremely strong. Business investment is
providing the demand. So far, production has not kept pace and unfilled
orders are rising. And with inventories so low, there is not much scope
to draw down stocks to fill these orders. Importantly, these trends are
in place in many other countries. Firmer demand and low inventories is
a combination that now exists in both Japan and Europe. The pressure
for faster manufacturing production is growing as each month passes.

For
industrial commodity markets, this is extremely bullish. While China is
a critical issue, the looming upswing in manufacturing production in
the OECD could put enormous upward pressure on the price of some
commodities. Basically, only a supply response is going to stop runaway
price hikes. With such a high starting point, it means that input price
pressures will remain a real concern for central banks. Higher interest
rates will be unavoidable with this backdrop.

There
have been plenty of warnings around the stock market that the
commodities cycle is topping out after such a strong run, but the
promise of another round of price increases will underwrite the
Australian market and economy well into 2006.
The inflationary
threat of input prices rising yet further has to be balanced against
the ability of manufacturers (mainly China) to continue to absorb costs
and produce more cheaply. It has primarily been China’s exporting of
deflation in manufactured goods that has kept the lid on inflation
overall during this very long, golden summer of economic growth.

There
are limits, though, to Chinese manufacturing aggression. Sharply rising
commodity prices plus a shortage of skilled labour (as opposed to
simple factory fodder) mean the era of Chinese-induced manufactured
goods deflation may soon be over.