Is $106 the Breaking Point for Oil?

Is $106 the breaking point for oil? First, some traders insisted $100 oil was the line in the sand: go over it, and our rally would falter. But it didn't happen: after a brief, three-week flutter, the major indices are knocking on the door of their old highs.

It didn't happen at $105 either. But today, as oil passed $106 to the highest level since late 2008, retailers like JCPenney , Macys , Lowe's and Home Depot are down one to three percent.

There's other, inflation-related issues as well: two big companies (Wal-Mart and Hershey ), made strong comments about the effect of inflation.

You will hear this a lot in the next few weeks: higher prices to cover inflation. But several traders have asked me a simple question: how do we know how much of these price raises are due to genuinely higher inflation costs, and how much is just an effort to raise prices to improve margins?

Take Hershey. The company said it was raising prices almost 10 percent across the board to cover higher costs for sugar, cocoa and dairy products. I have no doubt that prices are higher for these commodities, but 10 percent? That seems like a large price increase. (See: The 10 Hottest Commodities of 2011)

Look at it this way: Hershey's consensus revenue for fiscal 2011 is $5.95 billion. A straight across the board 10 percent increase would bring in roughly $600 million more. Their Cost of Revenue — rough costs — for fiscal 2010 was $3.2 billion. Assuming revenues will not be drastically different in 2011 over 2010, we are talking about cost increases of about 20 percent. Assuming all of the increase is due to inflation.

That's a hell of a lot of inflation! Is it really that bad? Maybe it is. Remember something else: we know Hershey hedges against commodity costs (they so say at the end of the 10-K), but we don't know at what prices Hershey is hedged. The company has said they will not see any benefits from the price increases until next year.

Regardless: what it means is that Hershey has pricing power.

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