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Food And Energy Expenditures At Rock Bottom, Could Become An Inflationary Force

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by: Jason Tillberg
Summary

June's Personal Consumption Expenditures report completes the first half of 2019.

Combining food and energy, the share of spending on the two is at a record low.

The strong dollar and lack of supply disruptions are creating clear skies for US consumers.

This deflationary force could be coming to an end and may turn into an inflationary force.

Both food and energy expenditures as a share of total personal consumption are at or near record lows. When combined together, they are at a record low for the first half of 2019.

Between a very strong dollar and lack of any major supply disruptions in both food and energy, the skies are quite clear these days.

This decline in food and energy as a share of expenditures has been a deflationary force.

A weakening dollar and or any major supply disruptions in either food or energy supplies will prove inflationary.

My forecast is that we are far more likely to foresee an inflationary force between these two components vs. any more deflationary force.

We could very well be at rock bottom.

Food

In 1901, the average household in the United States spent 42.5% of their income on food.

From then on out, with gains in productivity due to farming methods, tractors, fertilizers, and of course, pesticides, coupled with improved transportation methods and refrigeration, the share of household income going to food has been in decline.

Even up to today, the share of food expenditures as a percent of overall personal consumption expenditures has continued to decline.

By 1960, the share of expenditures on food was down to 19%. Fast forward 59 years, for the first half of 2019, just 7.1% of personal consumption expenditures went toward food.

This more or less falls in line with the Food and Agriculture Organization of the United Nation's own food price index that shows food commodities having not moved very much in recent history.

Source: FAO

Energy

When we look at energy, we are looking at electricity, gasoline and sources to heat our homes mainly.

Natural gas is the number 1 source of energy for the generation of electricity in the US. In 2018, it made up 35.1% of the total source for electricity generation.

Take a look at the price of natural gas, priced in million BTU:

The nominal price of natural gas is lower today, as of June 2019, at $2.40 per million BTU, than it was in January of 1997, when it was $3.45.

The price of oil is down to levels it was in 2005, averaging $54.66 in June.

Between the low commodity prices of both natural gas and oil, the share of personal consumption expenditures going toward energy is hovering around an all-time low at 4%.

Food and Energy Combined

Food and energy expenditures, when combined, have reached record low as a share of total personal consumption expenditures in the first half of 2019.

For the first half of 2019, 11.1% of personal consumption expenditures went toward food and energy.

US Dollar

Another critical component to the low cost of energy and food is the price of them in the said currency. We look at everything in terms of the US Dollar.

A rising dollar, that is, relative to other currencies like the euro or Mexican peso, helps to reduce the cost of commodities for anyone buying them in dollars.

At the same time, a weakening dollar would contribute to commodities rising is US dollars.

The dollar is quite strong again and that has contributed to helping to keep food and energy prices low, coupled with lack of major supply disruptions and other gains in productivity.

Here is a chart of the real trade weighted U.S. Dollar index.

The major peak was in 1985 when the Plaza Accord took place between the G5 to actually broker a deal to reduce the value of the dollar so to help the trade imbalance.

President Trump would like to see the dollar weaken to help fix the trade gap as the current strong dollar makes our exports more expensive for foreigners to buy. The Fed cutting interest rates could help contribute to the weakening of the dollar as the interest it would bear would decline.

So there is good reason to suggest that our dollar is currently in a state of being quite strong and the future looks more likely that it would decline relative to other currencies.

Future Inflationary Force

When I look at all the factors that contribute to the cost of food and energy, everything seems favorable. Strong dollar, lack of any supply problems and overall very low commodity prices.

One thing I would not bet on is that this declining trend in motion is going to stay in motion.

Since the first half of 2008, when the share of personal consumption expenditures going toward food and energy was nearly 14%, it has been in decline, now down to just 11.1%. This has been an 11-year decline.

This decline has been a deflationary force.

I'm forecasting that in and around the next 1-10 years, food and energy could prove to be an inflationary force.

These low prices of food and energy may be reducing investment for future production.

For example, agriculture loans have been in decline since the 4th quarter of 2015.

The Fed is likely to lower interest rates and that should both weaken the dollar and might light a fire under lending and borrowing, improving overall credit growth.

Both of those factors might cause speculation in commodity prices and that could be a reason for food and energy prices to rise.

Rising food and energy costs would contribute to a stagflationary environment. One where the economy is barely growing yet prices are rising.

Investment Implications

If inflation heats up, say to 3%-4% per year, longer-term bonds with low yields would suffer.

Higher inflation that comes from rising commodity prices, shortages, lack of productivity growth and a weaker dollar could wreck havoc on the bond market as investors would be trying to price these assets relative to the rate of inflation. Prices of the bonds would fall so to bring up their yields.

Input costs for businesses would rise and there would be less capacity to raise prices and pass those rising costs on to the consumer, thus hurt profits and share prices too.

In such an environment, gold (GLD) could very well prove to be the asset to own.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.