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Tuesday, April 5, 2011
When Will Commodity Prices Fall?
Contractors, especially those in the retail sector, have for months watched helplessly as building costs have escalated. A glut of resale homes and empty office space and American consumers’ bunker mentality on their purse strings as they wait out the economic siege have left contractors powerless to pass the creeping price increases along to consumers. Meanwhile, their wafer-thin profit margins get shaved even closer.
The culprit is commodity prices. In fact, residential construction costs have fallen significantly from their highs in September 2008, according to National Association of Home Builders Senior Economist Bernard Markstein. That crumb, tossed to builders by the recession as it gluttonously gobbled up job opportunities, sustained contractors throughout the worst of the downturn. Construction costs remain well below those 2008 levels, no thanks to lumber, steel, copper, and most of the other raw materials that go into houses, apartments, schools, and bagel shops. Still, “hard” construction costs represent almost 60 percent of a new home’s sticker price, up from 50 percent less than a decade ago. Markstein noted. Commodities are the blame for more than 100 percent of that increase. In fact, with slackened demand driving land costs lower, competition for a slice of the shrinking pie forcing commissions paid to realtors lower, and bare-bones operating budgets – including marketing – streamlining overhead costs, nearly every other component of a house’s selling price has plunged since 2002.
Profits have not been immune. Markstein says contractors earn less than 9 percent profit on their home sales today, compared with about 12 percent in 2002, as they absorbed the commodity price increases caused by soaring global demand, labor issues and natural and political events that limited supply, conservative development policy, speculation, and more.
The common and easy explanation for the inflationary nation of commodities is that China, Indonesia, India and other developing countries are sucking up the world’s steel and concrete as they modernize their infrastructure and their citizens develop more Western – read consumer-oriented – sensibilities. There is much truth to this analysis. But it only goes so far in explaining how construction commodities, especially those produced in the United States, have seen their prices rise in an environment of stagnated markets.
Investment advisors Goldman Sachs provides another part of the reason – one it identified in a report a year and a half ago in suggesting investors dive into the commodities market:
[T]he commodity problem is, at heart, a supply shortage due to decades of suboptimal investment, which has been exacerbated over the past year by the sharp drop in prices and tight credit conditions. As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the markets balanced.
This would point to price increases being temporary, as basic economic principle takes hold and quantity is regulated upward as dictated by the availability of excess profits. When mines, mills, factories, and farms believe demand for their products is sustainable, Markstein writes, they will reopen shuttered plants and increase their production capacities; prices will return to normal. Currently that confidence does not exist.
On the other hand, a recent Economist story points out disturbing evidence that the current commodity price cycle could last well into the next decade. The premise is that “the current surge in commodity prices, at a time of spare economic capacity in the rich world, suggests [e]ither the needs of the developing world are causing demand growth to outstrip supply for an extended period, or new sources of supply can be found only at higher cost. Both explanations add weight to the idea of a “commodity supercycle”, a long-term surge in prices that might last for 15-20 years.”
Still another reason for the confounding commodity inflation is Wall Street’s willingness to take Goldman Sach’s advice and play the market. The Federal Reserve Bank gave this investment strategy a boost late last year with its quantitative easement policy announced late last year. That effectively drove investors out of the bond market. Seeking alternatives, many planted their money in commodities. Increased demand = higher prices.
Anirban Basu, chief economist for the Associated Builders and Contractors, reports that all these causes are putting additional continuous pressure on contractors in their efforts to ride out the economic storm. “With the cost of construction rising in many instances, developers and others may choose to further delay construction starts. This, of course, represents bad news for an industry already associated with an unemployment rate above 20 percent and spending volumes that are nearly 25 percent below late-2008 levels. The hope is that speculators will not continue to pour money into commodities and that material prices will be better behaved in the months ahead,” Basu said.
Whether the current surge in commodity prices is temporary, caused by low production capacity or the beginning of a long-term “supercycle,” contractors who can adapt will be in positions of competitive advantage by finding viable material alternatives and using scarce resources more efficiently.
Contractors, especially those in the retail sector, have for months watched helplessly as building costs have escalated. A glut of resale homes and empty office space and American consumers’ bunker mentality on their purse strings as they wait out the economic siege have left contractors powerless to pass the creeping price increases along to consumers. Meanwhile, their wafer-thin profit margins get shaved even closer.
The culprit is commodity prices. In fact, residential construction costs have fallen significantly from their highs in September 2008, according to National Association of Home Builders Senior Economist Bernard Markstein. That crumb, tossed to builders by the recession as it gluttonously gobbled up job opportunities, sustained contractors throughout the worst of the downturn. Construction costs remain well below those 2008 levels, no thanks to lumber, steel, copper, and most of the other raw materials that go into houses, apartments, schools, and bagel shops. Still, “hard” construction costs represent almost 60 percent of a new home’s sticker price, up from 50 percent less than a decade ago. Markstein noted. Commodities are the blame for more than 100 percent of that increase. In fact, with slackened demand driving land costs lower, competition for a slice of the shrinking pie forcing commissions paid to realtors lower, and bare-bones operating budgets – including marketing – streamlining overhead costs, nearly every other component of a house’s selling price has plunged since 2002.
Profits have not been immune. Markstein says contractors earn less than 9 percent profit on their home sales today, compared with about 12 percent in 2002, as they absorbed the commodity price increases caused by soaring global demand, labor issues and natural and political events that limited supply, conservative development policy, speculation, and more.
The common and easy explanation for the inflationary nation of commodities is that China, Indonesia, India and other developing countries are sucking up the world’s steel and concrete as they modernize their infrastructure and their citizens develop more Western – read consumer-oriented – sensibilities. There is much truth to this analysis. But it only goes so far in explaining how construction commodities, especially those produced in the United States, have seen their prices rise in an environment of stagnated markets.
Investment advisors Goldman Sachs provides another part of the reason – one it identified in a report a year and a half ago in suggesting investors dive into the commodities market:
[T]he commodity problem is, at heart, a supply shortage due to decades of suboptimal investment, which has been exacerbated over the past year by the sharp drop in prices and tight credit conditions. As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the markets balanced.
This would point to price increases being temporary, as basic economic principle takes hold and quantity is regulated upward as dictated by the availability of excess profits. When mines, mills, factories, and farms believe demand for their products is sustainable, Markstein writes, they will reopen shuttered plants and increase their production capacities; prices will return to normal. Currently that confidence does not exist.
On the other hand, a recent Economist story points out disturbing evidence that the current commodity price cycle could last well into the next decade. The premise is that “the current surge in commodity prices, at a time of spare economic capacity in the rich world, suggests [e]ither the needs of the developing world are causing demand growth to outstrip supply for an extended period, or new sources of supply can be found only at higher cost. Both explanations add weight to the idea of a “commodity supercycle”, a long-term surge in prices that might last for 15-20 years.”
Still another reason for the confounding commodity inflation is Wall Street’s willingness to take Goldman Sach’s advice and play the market. The Federal Reserve Bank gave this investment strategy a boost late last year with its quantitative easement policy announced late last year. That effectively drove investors out of the bond market. Seeking alternatives, many planted their money in commodities. Increased demand = higher prices.
Anirban Basu, chief economist for the Associated Builders and Contractors, reports that all these causes are putting additional continuous pressure on contractors in their efforts to ride out the economic storm. “With the cost of construction rising in many instances, developers and others may choose to further delay construction starts. This, of course, represents bad news for an industry already associated with an unemployment rate above 20 percent and spending volumes that are nearly 25 percent below late-2008 levels. The hope is that speculators will not continue to pour money into commodities and that material prices will be better behaved in the months ahead,” Basu said.
Whether the current surge in commodity prices is temporary, caused by low production capacity or the beginning of a long-term “supercycle,” contractors who can adapt will be in positions of competitive advantage by finding viable material alternatives and using scarce resources more efficiently.
Labels: Commercial, Construction Industry, Industrial
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