Hot commodity

Larry Kudlow
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Posted: Oct 20, 2003 12:00 AM

Take a look at commodities. What do you see?

Metal prices have skyrocketed to a 30 percent rate from a 5 percent decline rate over a year ago. Raw industrials have moved from zero percent to 21 percent.

For supply-siders, those are some very sexy numbers. They represent the real recovery that is finally taking place in the hard goods world of industrial production and inventories. In both economic and political terms, these commodity gains spell jobs, jobs, jobs.

Here's what's going to happen. The next several quarters will produce 5, 6 or 7 percent economic growth. Big profits, perhaps as high as 20 percent, will mark these quarters. Outsized sales revenues will also materialize. It's a complete sea change from the tepid, sub-par recovery we've witnessed since the end of 2001.

There are many reasons for this. First, genuine liquidity creating from the Federal Reserve has ended business price deflation and provided the grease for the wheels of commerce. Second, tax cuts -- effective immediately this past spring -- have provided a recovery jolt to the business and investment side of the economy. That includes stocks. Third, inside the economy, historic productivity gains have not only made companies more efficient, they have held down costs and triggered massive profits.

Additionally, the strongest growth economy in the world today -- China -- is creating huge demands for commodities and tech components. In baseball terms, the United States has its own farm team in China. It absorbs the Yankee player surplus, but will feed back players to fit key roles along the way.

Not surprisingly, the most successful performing stock market sectors have been Internet and information technology. These areas are the most leveraged to economic growth. (They're followed in the equity pecking order by consumer cyclicals, basic materials, industrial smokestacks and financials -- which are also highly leveraged to economic growth.) The single biggest technological influence today is the rapid spread of fast-time broadband connections over the web. Broadband makes all Internet information services and commercial businesses more attractive and easier to access. It's an integral part of this recovery.

Of course, there is no better barometer of business conditions and the future economy than the stock market. Over the past year, the U.S. stock market has restored nearly $3 trillion of lost wealth. Add this to the roughly 40 percent after-tax decline in the cost of U.S. capital and the return on U.S. investment, and then add in the barrelfuls of new money injected by the Federal Reserve, and you can see why we are on the front end of an explosive growth recovery.

And it will be a non-inflationary boom. The gold price provides the best inflation metric out there, and it's telling us that deflation is over and that inflation has not arrived. Two years ago, the world gold price was $250, a signal of deflation. Today's price is about $370 per ounce, which signals reflation. Had gold moved up to $425 or $450, it might have triggered high-interest-rate inflation expectations. But $370 is a comfortable reflationary level.

Supply-siders understand that roaring raw-material indexes are a sign of an industrial recovery, not inflation. They also know that lower tax rates, more liquidity, high productivity, a rapid spread of broadband and strong profits are the building blocks of the next boom.

Think of this: In the early 1980s, almost no one expected a real prosperity wave. Still, we got one. It was the same case in the early 1990s. Right now, pessimism abounds, but the naysayers will be wrong again. The combination of rapid technological advances and market economics is a powerful pro-growth elixir. It has worked well in the past, and it will do so again.