UNEDITED

Over the past two years commodity prices have steadily increased, some rather dramatically. Even as the Commodity Research Bureau (CRB) Index has soared almost 50% since the beginning of 2002, there has been very little increase in inflation according to the government and Federal Reserve. The Consumer Price Index has only risen by 5% over the same time frame. There is starting to be increasing anecdotal evidence the rise in commodities might start hitting consumer's pocket books.

This week, Kimberly Clark announced it will raise prices on its paper products by 6% due to price increases in raw materials and energy. Whether or not the increases will actually get done, it still signals that profit margins are staring to get squeezed by increasing prices. Pulp prices have 6% already this year and are up almost 30% since the beginning of 2002.

Steel is getting the most ink lately having almost doubled since last summer. Steel Dynamics announced that it now expects to earn between 50 cents to 60 cents per share this quarter versus previous guidance of between 35 cents to 45 cents per share. The company said, "Improvement in the demand for flat-rolled and structural steel during the quarter has resulted in stronger selling values than we first anticipated." This followed Nucor, which announced last week its earnings for the first quarter will be about double initial forecasts. The largest US steel producer said it will earn between $0.80 to $1.00 per share instead of between $0.40 and $0.60 per share. Similar to Steel Dynamics, the company said, "Increased pricing and the strengthening of global and domestic demand for steel have contributed to a better than expected first quarter." Both these steel companies produce steel by melting scrap steel. Scrap steel has also experienced a huge run. A recent UBS research report said that scrap steel is up 150% since last summer. Both companies It also added a surcharge in order to keep "pace with the continued increase in scrap prices."

General Motors is one of Steel Dynamics customers and has been paying the surcharges so deliveries would not be interrupted. Last week, GM filed suit against Steel Dynamics for reimbursement of the surcharges which were above the contracted price. The auto industry will have a significant burden if the price of steel remains at these levels, not to mention if it continues to rise. UBS issued a research piece discussing the rise in steel and the possible repercussions. Most of the steel used in the auto industry is purchased using long-term contracts and most industry analysts believe the increase will be short lived and will not cause too much disruption in the auto industry. However, it the price of steel does not decline there will be a lot of profits squeezed from the industry. UBS estimates that with the current price of steel it would add $300 to the cost of a vehicle. Considering that Ford's average pretax profit per vehicle last year was $462 and General Motor's was only $262, taking $300 out of profits would be significant. It will be difficult for the suppliers to absorb the cost since the $3 billion to $4 billion incremental cost is more than nine suppliers UBS covers earned last year, combined.

One factor that has kept the price of steel high is the decline in the US dollar. Because of the dollar decline it has not be attractive for foreign companies to ship steel to the US. This is starting to change. A story from Metal Bulletin reported that the US now has the highest price for steel, surpassing China. The article cited bookings at $520 to $540 per ton, up from $420 to $440 just a few weeks ago.

China is most often cited as the reason for the increase in most commodity prices. There is wide consensus that China has been purchasing as much scrap steel as possible. Oil is another commodity that has been bid up due to increased China demand. This is also evident in the increase in shipping prices. The average daily cost of an oil tanker from the Middle East to east Asia has jumped 22% over the past year to $82,300 per day. The increase to the US has increased only 12% to $63,000 over the past year. The pressure is unlikely to end anytime soon. The International Energy Agency increased its forecast for China demand to over 6 million barrels of oil per day, 10% higher than last year.

The global economic reflation is benefiting corporate sales and earnings. Earnings estimates have been rising and analysts now forecasts that the S&P 500 will increase 15.1% (excluding Lucent) compared to 13.1% at the beginning of the year. Rockwell Automation announced it now expects to earn between 37 cents to 39 cents per share, up from the 35 cents to 38 cents forecasts just two weeks ago. Additionally, the company increased the bottom end of its previous guidance for the full year to between $1.40 and $1.45 per share. Previously the bottom end of the range was $1.35.

Limited Brands increased their expectations for same store sales growth to low double digits from mid single digits. It has experienced "stronger than expected performance at Victoria's Secret and to a lesser extent, Bath & Body Works." Additionally, the company said this will boost EPS to between $0.11 and $0.13 per share from earlier EPS guidance of $0.09.

Carnival Corp. announced that earnings were 25 cents per share, beating estimates by three pennies. It reported that bookings were running about 62% ahead of last year and pricing is about 6% higher than last year. Obviously, the year ago comparisons were depressed due to the concern over the war so the better results are expected. The companies COO, Howard Frank, said that it is "starting to see, I think, a lot of pent-up demand coming back into the marketplace and people trying to get their bookings done now in anticipation of the possibility that prices could start to move up." The company increased its guidance for the full year from $2.02 per share to between $2.05 to $2.15.

The consumer has continued to be alive and well. Wal-Mart announced its same store sales were tracking near the high end of it 4% to 6% plan and Target said its sales were exceeding its plan of 4% to 6% same store sales. This week, West Marine announced that its sales have been much better than expected and increased its estimate for same store sales for March and for the first quarter. Instead of 4% to 5% growth in same store sales, the country's largest specialty retailer of boating supplies, expects same store sales to advance 11% to 14% during the quarter ending March 31.

The surge in commodity prices is directly related to the attempts to reflate the economy. While the reflation has certainly caused economic activity to increase, none of the imbalances that were created during the late 1990s were rectified. Now, more imbalances are being created and will likely end with greater consequences down the road.