Price rises of 65% in iron ore and 90% in wheat must be passed through to customers. But steel mills and bakeries lack the profit margins to absorb jumps of this magnitude. They will entrench inflationary expectations among both consumers and manufacturers. That suggests much higher and intractable inflation lies ahead, making a “cheap money" policy untenable.

The South Korean steel company, Pohang Iron and Steel Co. (Posco), is the most efficient steel manufacturer in the world. It also sells substantially into China’s rapidly growing market. However, it lacks control of its raw material base since Korea has no iron ore. Thus the 65% dollar price increase on its iron ore supplies imposed by Companhia Vale do Rio Doce on 18 February can only be reflected in higher steel prices to customers.

Similarly, the 90% increase in winter wheat prices in the past six weeks will produce higher bread prices. While bakeries generally absorb raw material price fluctuations, they lack the margins or financial strength to absorb cost increases of this magnitude.

By these mechanisms, commodity price increases become reflected in consumer price indexes, albeit with a lag. January’s increase of 1.4% in US import prices suggests that that process is accelerating. Unless commodities prices fall back sharply, consumer price indexes must soon reflect these cost increases.

Commodity prices have been rising because of the excess worldwide supply of money, stemming initially from the lax monetary policies of Fed chairmen Alan Greenspan and Ben Bernanke since 1995. Commodity price rises have recently been accelerated by the Fed’s federal funds rate cuts from 5.25% to 3%, intended to reliquefy the money markets.

As consumer price inflation increases, a 3% federal funds rate becomes increasingly unsustainable. If policy is not changed voluntarily, the bond market will force change, through sharp declines in treasury bond prices and failure of US government debt auctions. It is thus notable that in spite of the global “flight to quality," 10-year treasury bond yields have risen from 3.28% to 3.83% in the last month.

The era of low inflation appears to be ending; the era of cheap money cannot survive it for long.

Primary Real Estate plans $500 mn fund

Indian fund manager Primary Real Estate Advisors Pvt. Ltd plans to launch a fund worth as much as $500 million (Rs2,010 crore), probably in the second half of this year, but said it will tread carefully as the country’s property boom stutters.

Foreign investors have taken advantage of such funds to rush into property development in India since it eased rules on inward investment in the construction industry in early 2005, sparking rampant land speculation and a near quadrupling in prices.

But despite signs of a slowdown—home sales volumes have fallen by one-fifth in Mumbai and 40% in Bangalore in the last year—the head of Primary Real Estate, Ashwin Ramesh, is convinced that North American and European investors will invest. “There are certainly cowboys out there," Ramesh said. “But our style is more focused for a risk averse environment."

“We would typically underperform in a raging bull market but overperform in a flattish market."

Ramesh said he expected to launch the new fund within six months to a year, and hoped to raise between $300 million and $500 million.

“At the moment there’s interest in North America and London, but we’re in touch with people all over the place," he said, adding that he was busy expanding a team that is now investing a $32 million fund closed in mid-2007.

Primary Real Estate would aim for internal rates of return of 15-20%, Ramesh said, below the usual 20-25% often advertised by funds in Asia’s up-and-coming property markets of India, China and Vietnam. Rival India-based funds include Trikona Capital and Kotak Maihindra Investments, while Citigroup Property Investors and Morgan Stanley Real Estate have been at the forefront of a wave of global funds entering the country.

The demographic fundamentals for India’s real estate boom touted by analysts appear compelling for many investors. But developers have crammed projects into a few cities and certain building types, Ramesh said.

Primary Real Estate, which will team up with developers —“high quality people, that’s our first filter," Ramesh says— has identified a big township project outside Mumbai and will seek out projects in emerging cities. Dominic Whiting/ Reuters