Under the recent information deluge, we haven’t had the time to analyze a very interesting and disturbing trend. The U.S. business inventory to sales ratio has been rising for months. What does it mean for the American economy and the gold market?
According to the Monthly Wholesales Report, inventories were up 6.2 percent in January from a year ago and 0.3 percent from December. Coupled with weak sales data (sales fell by 3.1 percent from December 2014 and 1 percent from January 2014), the inventory to sales ratio increased to 1.35 in January from 1.33 in December 2014. It means that it would take 1.35 months for businesses to clear shelves, the highest inventory-to-sales ratio since July 2009.
Why is data on business inventories so important? The answer is that the changes in the inventory to sales ratio indicate any supply or demand imbalances in the economy. Inventories rise when supply is greater than demand. Inventories rising relative to sales mean that sales fail to meet demand projections. Thus, the inventory to sales ratio usually reaches its cyclical peak in the middle of the recession, when the economy is slowing down. Indeed, please note three things.
First, that inventories of durable goods jumped the most – by 7.7 percent from year ago, which is generally in line with weak data on news orders for durable goods. Second, contrary to the historical declining trend (due to improved inventory management), we are witnessing a gradual rise since 2013 and particularly since the summer of 2014. Actually, the inventory to sales ratio has reached the highest level since the Great Recession (see the chart below). Third, inventories are rising despite low prices. Thus, this indicates week global demand.
Figure 1: Total business inventories to sales ration from 1994 to 2015.
The consequences may be significant. The high levels of inventories could make entrepreneurs very uncomfortable with adding more stocks. Thus, they will probably try to reduce their orders to get inventories in line. However, those orders are the suppliers’ sales. It means that reducing stocks and cutting orders may trigger a spiraling decline in sales and a recession. After Lehman, businesses reduced orders so aggressively that the supply chain seized, sales went down and inventories soared.
To sum up, inventories should not look only at the Fed’s actions and speeches, but also analyze fundamental data. The inventory to sales ratio is of utmost importance, since it shows the supply/demand imbalances. The rising ratio indicates that the U.S. economy is slowing down due to weak demand. The report on U.S. durable goods orders is good news for gold prices, because the possible recession could boost safe-haven demand for gold and change the Fed’s monetary policy stance to even more dovish.
Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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