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Fallen and Can't Get Up, Industrial Prices Point to Weakness

Industrial production is sliding globally and there is no bottom in sight. That, says Anirvan Banerji, chief economist at the Economic Cycle Research Institute, is what the JOC-ECRI Index, a widely watched leading inflation gauge, indicates.

The index, which tracks the prices of 18 key industrial commodities, fell to its lowest level in 30 months last week. Its growth rate, which shows whether the industrial sector is expanding or contracting, "has plunged," says Banerji. After recovering to negative 2% growth on May 22 from minus 13% earlier in the year, it has since contracted at a 14.7% rate.

"I've rarely seen such unanimity out of the 18 components," he says. "It is very pervasive." Fourteen of the index's prices are heading down.

"This is a very international industrial recession, and things will get worse before they get better," says Banerji. U.S. industrial production has fallen for nine straight months, bringing capacity utilization down to 77%, its lowest level since 1983...

The reason: In metals, unlike oil, there is no constraint on storage. As producers continue to mine and fabricate metal because of the high cost of plant shutdowns, inventories just get bigger.

The damage already is apparent. Producers of zinc have recently seen their prices collapse to the lowest level since January 1988. Aluminum, copper and nickel producers are doing only slightly better; prices of their wares are now hovering at their lowest levels since 1999.

Major producers such as Alcoa, Alcan, Phelps Dodge and others need to recognize they are in a falling market. But there has been no net decline in production of these items. Some producers in, say, aluminum have shuttered capacity in the Pacific Northwest amid high power prices. But other global producers, such as the Chinese, have expanded output. As a result, inventories of aluminum and copper are up 100% at the London Metals Exchange.

With demand sliding and output holding up, buyers are moving their bids lower. Lower interest rates also reduce the cost to carry metals, putting pressure on future prices. Thus, weakness in the physical market is carrying through to forward prices. Cash prices, as a result, have and will continue to lead futures prices.

Consumers of metals such as construction companies and homebuilders should sit back and enjoy the current weakness and stay exposed to further price declines. But later on, they should look to take advantage of the weakness in forward curve prices by building hedge positions...

OPEC last week said it would shave back crude oil output by 4%, or one million barrels per day, in September, to try to stabilize falling prices amid a slowing world economy. Prices rallied nearly 7% on the news before fading by Thursday and ending the week at $27.02.