Scrawls from Preston...

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Sat 07 June 2008

Why the oil price tidal wave of inflation is building

This article in the NY Times has several passages that I think illustrate why there are at least two phenomena that could be leading to a delayed impact of the current high oil prices.

First - There is an issue of the latency in large production quantities of both raw materials and finished goods. Dow Chemical may make a batch resin, that then is made into luggage. Each of these is made in relatively large production runs, then may be bought in large shipments. Each of these steps adds a certain amount of time buffer. Here is a quote from the above article

Costco’s profit was up in the first quarter, but \ `James D. Sinegal`_, the chief executive, says he is “starting to be confronted with unprecedented price increases� for the merchandise that Costco buys to stock its stores. His first response has been to buy in extra large quantities so that he has stock on hand to carry him through subsequent price increases. .. raw:: html

.. raw:: html

“We just made a big purchase of Tumi luggage,� Mr. Sinegal said.

So the 138 barrel oil prices are just making their way into some of the raw chemical materials now, they may take months before these higher prices reach the inventory of the luggage maker, and it may be months more before Costco has to buy another big shipment of the now much more expensive luggage. We may watch oil prices hour by hour, or day by day - but the impact many highly processed complex products can lag quite a bit.

Second and perhaps a bigger issue is that companies, under the general impression that oil prices will be going back down, and in a highly competitive retail market, have decided to not pass on many of the energy cost increases, but instead have taken the hit in their own profits. As profits were high at the start of the recent run up in oil prices, they could afford to be a buffer - but as oil prices stay high, and profits continue to shrink, they will have to pass on these higher energy costs.

Since last spring, the average profits of the nation’s corporations — from behemoths like Goodyear to small neighborhood retailers — have declined at an annual rate of nearly 6 percent, government data show.

If this rate continues, companies will HAVE to pass on the higher costs to maintain any profit, and then inflation, which has been hidden by this buffering has the potential to slam hard - on top of continued job cuts and decreased corporate profits (read stock prices), and the housing decline etc etc. I guess you could label me a bear.