Musings from the Oil Patch
Comment of the Day

July 17 2012

Commentary by Eoin Treacy

Musings from the Oil Patch

Thanks to a subscriber for this edition of Allen Brooks ever interesting report for PPHB. Here is a section on the impact of commodity prices on consumer spending:
In this case, the Bespoke analysts tracked the price changes for corn, soy, wheat, cattle, hogs, crude oil and natural gas. They multiplied the daily price changes by the annual per capita consumption of each item. While this methodology has the impact of oversimplifying actual costs, it does provide a legitimate way to estimate the impact of raw commodity price changes on consumers and their spending.

The analysts assumed that if the cumulative change was zero then there was no impact on consumers. If changes were positive, this had a negative impact on consumer spending. Likewise, falling commodity prices should provide a benefit for consumers. Exhibit 2 shows the record of the Bespoke analysts' commodity price calculations and the estimated impact on consumers.

At its peak, commodity price inflation cost the consumer about $4.77 per day heading into the summer of 2008, the point at which the global financial crisis exploded onto the economic scene. The financial crisis and resulting recession undercut commodity demand and prices helping to boost consumer incomes in the spring of 2009 by nearly five dollars per day, and acting as a stimulus for economic recovery. That maximum consumer benefit arrived just prior to the determination by the National Bureau of Economic Research that the recession had ended in June 2009. From that point forward, the global economic recovery, coupled with loose monetary conditions as cited by Professor John Taylor, drove commodity prices higher and cut into consumer incomes to the point that by last summer they had become a drag on spending. Since then, commodity prices have weakened and as of late June were helping boost consumer spending by $2.17 per day.

Bespoke analysts recognized that the $2 per day number contributes little to investor understanding of the benefit of lower commodity prices on consumers. They point out that $2 per day when annualized amounts to $795 per person per day. For a family of four it means $3,175 per year in additional income not absorbed by the food and energy products they normally consume. As the median annual household income for U.S. families of four in 2010 was $61,544, this savings is the equivalent of about a 5% boost to their income, a welcomed event even though it may not be immediately apparent to consumers.

Eoin Treacy's view While central banks conveniently dismiss the most volatile elements of one's cost base from their measures of inflation, there is no argument that food and energy prices have an impact on discretionary spending, particularly at the margins. It is for this reason that we have pointed out on successive occasions why spikes in crude oil prices play a pivotal role in shaping perceptions of economic health and as a result, stock market returns. (Also see David's piece on inflation above).

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