Yvonne Levy

English

Research Papers in Economics

May 2,1980 
How Good A Signal 
Prices of industrial raw materials declined 
sharply in March, leading many analysts 
to predict the onset of recession, the 
deceleration of inflation, or both. However, 
one month's statistics may not provide 
enough su pport for a defi n  ite forecast. It 
should be remembered, moreover, thatthe 
raw-materials price series has not always 
provided a sure signal of  the future direction 
of production and finished goods prices. 
In past business cycles, industrial-material 
prices have reached their,peaks, and turned 
downward, somewhat before the peaks in 
overall economic activity-butthe lead has 
been anywhere between 3 and 17 months. 
Moreover, downturns in raw-material prices 
have not always been followed by downturns 
in production, income and sales. The 
variability and occasional unreliability of  the 
price series thus has diminished its value as a 
recession forecaster. 
Much the same can be said of  the valueofthis 
series as an inflation forecaster. In past cycles, 
there have been long and variable lags 
between the peak rates of increase in 
industrial raw-material prices and nonfood 
finished goods prices. This suggests some 
difficulty in forecasting when a decline in 
raw-material prices will be translated into 
price moderation in the finished goods that 
producerssell. Moreover, in the past two 
cyclical expansions, consumer nonfood 
finished-goods prices peaked earlier than 
producer finished-goods prices, the opposite 
of  what one would expect in light of the fact 
that retail prices are posted at a later stage of 
the distribution cycle. 
Nonetheless, the behavior of raw-material 
prices does provide valuable information 
about the state of the economy because of 
their sensitivity to changing economic condi-
tions. Slowdowns in the demand for finished 
manufactured products are translated first 
into reduced demand for raw-materials 
inputs. And since most of these commodities 
are sold daily on organized exchanges, their 
prices respond quickly to changes in supply 
and demand of such materials. 
The raw-material price trend bears watching 
today, especially if  the sharp price break of 
March should be sustained. In March, spot-
market prices of 13 raw industrial materials 
declined at a 26-percent annual rate, 
compared with a 28-percent rate of increase 
in the first two months of the year. A similar 
index which includes energy prices-the 
crude nonfood materials index-dropped 
15 percent (annual rate) in March, following 
a 43-percent average rate of increase in the 
preceding two-month period. The difference 
between the two series could be explained by 
the continued rise in petroleum and coal 
prices-included in the latter but not the 
former series-which offset part of  the sharp 
drop in prices of copper scrap, steel scrap, 
hides and rubber. 
The March price decline, however, must be 
considered in the context of a sharp run-up 
which extended from early 1977 to early 
1980. Indeed, early 1980 witnessed the 
sharpest price increase since the 1973-74 
commodity boom. In this latest episode, a 
speculative buying flurry for gold and silver 
spilled over into the markets for nonferrous 
metals (especially copper scrap) while a 
sharp rise in OPEC oil prices caused a rapid 
rise in domestic producer prices for primary 
energy products. Consequently, the March 
raw-material price decline may best be 
described as the end of a speculative bubble, 
with some spillover from the recent liquida-
tion of gold and silver stocks. 
Caution in interpreting the latest price 
movement may be worthwhile, because 
crude-material prices have fluctuated widely 
since the beginning of the cyclical expansion 
of early 1975 (see chart). This volatility has 
reflected a series of  flurries in inventory buying, followed by a. series of inventory 
liquidations. In other words, several sub-
cycles in commodity prices have occurred 
within the broad cyclical expansion of the 
past half-decade. 
In the post-World War II period generally, 
spot-market prices for raw industrial com-
modities have peaked on the average 
9 months before the peak in general business 
activity, although with a range of 3 to 
17 months prior to the business-cycle peale 
Moreover, the lead has narrowed signifi-
cantly in recent business expansions, 
amounting to only 3 months prior to the 
November 1973 cyclical peak. To confuse 
matters further, the index containing energy 
prices failed to peak until 5 months after the 
1973 recession began, because of the impact 
of sharply rising petroleum prices. 
Prices of producer nonfood finished goods 
reached their peak rate of increase an average 
of 11  months after the peaks of  the last two 
business cycle expansions-that is, well into 
the recessions. In view of  this long lag, as well 
as the long lead of the spot-market index, we 
might have to wait until late in 1981  to see 
a deceleration in the producer finished-goods 
index in the current cycle. Predicting the 
movement of  consumer-goods prices may be 
even more difficult, considering the fact that 
consumer prices led rather than followed 
producerfinished-goods prices in each of  the 
last two business cycles. 
There are hazards too in predicting the 
magnitude as well as the timing of price 
movements from past price behavior. 
Between April 1974 and July 1975, the spot-
market price index for industrial commodi-
ties dropped 27 percent. This was followed 
by a sharp deceleration in producers' non-
food finished-goods prices, from a 25-percent 
annual increase in August 1974 to a 4-percent 
rate of increase in May 1976. But this does 
not mean that we should expect the same 
behavior in 1980-81, because many of the 
conditions present in that earlier period are 
not present today. 
In 1973, the industria.li?ed na.tions 
experienced a coincident boom in economic 
activity;  for  example,  with  the  capacity-
utilization rate in the U.S. industrial-materials 
industries reaching 93 percent-virtually full 
capacity. Because of an overheated world 
economy, shortages extended to nearly all 
basic industrial materials, and a shortage 
psychology led producers to expand their 
. materials inventories at practically any price. 
2 
Thus, in early 1974, prices for crude nonfood 
materials rose at an unprecedented 
74-percent annual rate. 
In early 1980, in contrast, inventory-sales 
ratios for basic materials remained relatively 
low, especially in contrastto the 1973-74 
situation. High interest rates recently have 
helped discourage heavy inventory accumu-
lation, with their burden of heavy carrying 
charges. Reflecting this situation as well as 
the lack of a worldwide commodity boom, 
the materials capacity-utilization index in this 
country stood at a high but not record level of 
86 percent in early 1980. And the industrial 
raw-materials price index, although soaring 
upward at a 43-percent annual rate during 
the first two months of 198D in the midst of 
the precious-metals splurge, did not approach 
the record high increase of early 1974. 
Most of the recent weakness in material 
prices-both at the raw and intermediate 
stages of processing-could be attributed to 
the slump in residential construction and 
auto production. A strike at British Columbia 
mills helped stabilize domestic lumber prices 
du ri ng the fi rst two months of 1980 after a 
sharp decline late last year in the wake of the 
U.S. homebuilding slowdown. But the pro-
ducer price index for lumber resumed its 
downward movement in March-falling at 
an annual rate of 19 percent (seasonally 
adjusted) -and a further decl ine is in pros-
pect for April. Between early March and late 
April  prices for certain key homebuilding 
items fell precipitously. For example, the 
price of Douglas-fir 2-by-4's fell from $210 
per thousand board feet to $160 per thousand 
board feet, while the price of Douglas-fir studs dropped from $198 per thousand board 
feet to $145 per thousand board feet. 
The u.s. producer price for refined copper 
reached a record $1.42 per pound in mid-
january-up nearly 40 percent in six weeks' 
time. But it has since fallen below its original 
level, to 94 cents per pound. This see-saw 
movement largely reflected the expansion 
and then the bursting of the speculative 
bubble in the markets for precious metals, 
along with declining U.S. consumption of 
copper. But copper prices could turn around 
later this year, in view of a prospective strike 
in the domestic industry and the relatively 
low level of  producer inventories worldwide. 
In other metals markets, lead and zinc prices 
have reflected the weakness in the auto i  ndus-
try. Aluminum prices, however, have contin-
ued to increase as a reflection of the strength 
in the aerospace industry. In early April, major 
aluminum producers raised primary-ingot 
prices from 66 to 72 cents per pound, thus 
bringing that quotation closer to the 90-cent 
price being charged by overseas producers. 
Annual  Rate 
of  Change(%) 
80 
60 
40 
20 
o I------"-'''----=-
-20 
1972  1974 
In the energy area, there is little hope for 
anyth i  ng but a modest deceleration in the rate 
of increase in prices as the year goes on. 
Futher OPEC price increases could be re-
strained by the slowdown in U.S. consump-
tion and by the brimful level of refinery inven-
tories throughout the world. But petroleum 
prices in the United States generally are 
bound to continue to rise in view of the grad-
ual decontrol of  domestic crude-oil prices 
and the imposition of  the gasoline import 
fee-and of course they would rise further if 
Iranian exports were to be cut off. 
In summary, the historical record suggests 
that a decline in raw-materials prices, if sus-
tained, will eventually lead to some decelera-
tion in producer and consumer finished-goods 
prices, but the exact timing of the decelera-
tion is uncertain. Moreover, barring a severe 
recession, recent developments suggest that 
the decline in basic industrial material prices 
may be smaller than durtng the 1974-75 re-
cession. In that event also, we may see less of 
a deceleration in finished-goods prices than 
we experienced in that earl ier cycl ica I  decl i  ne. 
PRODUCER  PRICES 
(Non-food) 
Finished  Goods 
Seasonally  Adjusted 
Yvonne levy 
1976  1978  1980 
3 U01~U!4SPM  ..  4Pln  ..  UO~ClJO ..  PPPAClN  ..  o4PPI 
!!PMPH  ..  P!UJOJ!IE':)  •  PUOZ!J\(  •  P)ISPIV 
(G)~<§~~'0]~JIdI  \ill~CS 
~  (G)  24I'0]~C£I 
@&JI@<§~CQI TI~JI@P@dI 
JJ, \ill ~  \~IW  JJ,JJW:cdI ~cm ~J)  JJ W. ~<§~  CQ[ 
BANKING DATA-TWELFTH fEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
Large Commercial BanlG 
loans (gross, adjusted)'and investments* 
loans (gross, adjusted) - total# 
Commercial and industrial 
Real estate 
loans to individuals 
Securities loans 
U.S. Treasury securities* 
Other securities* 
Demand deposits - total # 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total # 
Individuals, part. & corp. 
(large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+ )/Deficiency (-) 
Borrowings 
Net free reserves (  + )/Net borrowed( -) 
.  * Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
4/16/80 
138,723 
116,913 
33,864 
45,846 
24,432 
1,038 
6,534 
15,276 
46,362 
32,945 
26,599 
63,255 
54,530 
22,499 
Weekended 
4/16/80 
34 
31 
4 
Change 
from 
4/9/80 
- 764 
- 776 
- 26 
+  114 
+  38 
+  31 
+  9 
+  3 
+  1,215 
285 
- 460 
+ 
+ 
+ 
+ 
+ 
-
-
+ 
+ 
+ 
-
Change from 
year ago 
Dollar  Percent 
13,668  +  10.9 
14,969  +  14.7 
3,470  +  11.4 
9,140  +  24.9 
2,943  +  13.7 
477  - 31.5 
1,520  - 18.9 
219  +  1.5 
2,341  +  5.3 
766  +  2.4 
3,322  - 11.1 
+  304  +  13,728  +  27.7 
+  98  +  14,330  +  35.6 
+  37  +  5,435  +  31.9 
Weekended  Comparable 
4/9/80  year-ago period 
28  12 
200  46 
- 172  58 
Editorial comments may be addressed to the editor (William Burne) or to the author ....  Free copies of this 
and other Federal Reserve publications can be obtained by calling or writing the Public Infonnation Section, 
Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184. 

How good a signal

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How good a signal

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Research Papers in Economics