Commodities: Bubble Or No Bubble?

06/16/2008 12:00 am EST


Eric Roseman

Editor, The Commodity Trend Alert

Eric Roseman, editor of Commodity Trend Alert, says many commodities are far from their historic highs, so they don't meet the definition of a bubble.

Are commodities in a "bubble"? 

Though some commodities shouldn't trade at current lofty levels based on supply and demand factors, the majority of the complex, determined vis-a-vis futures contracts are priced relatively accurately. In fact, many commodities, including soft agricultural commodities and the precious metals, still trade miles below their inflation-adjusted peaks since 1974 or 1980.

It's hard to accept an argument that corn, for example, is in a "bubble" when adjusted for inflation since 1974 prices are still 54% below their peak. The same goes for soybeans-still one-third below its highs and gold 60% below its inflation-adjusted high in 1980. 

It's simply inaccurate to label most commodities in a "bubble" when other compelling supply-side factors are determining price trends-declining supplies, volatile weather patterns, low US interest rates and of course, a plunging US dollar since 2002.

Since the peak in commodities markets more than 28 years ago, global production of virtually every segment of the industry either declined or stagnated amid low prices and a glut for raw materials. Making matters worse, devastating weather patterns continue to adversely affect crop yields in some markets, namely Australia and Ukraine.

Also, Russia's virtual collapse in the late 1990s resulted in a massive dumping of raw materials to desperately raise hard currency; coupled with the Asian economic crisis, which resulted in plunging demand for commodities: The asset class hit rock bottom by late 1998.

With super-low interest rates in the United States by 2003 and easy monetary policy almost everywhere else this decade, investors and speculators have redirected assets to inflation hedges or tangible goods like commodities. China, of course, continues to devour almost every conceivable raw material to power its wonder economy. With supplies not growing by any significant measure over the last 20 years, it's no surprise prices have skyrocketed.

It's almost absurd to blame commodity price inflation only on speculators and index funds; futures investments of all public pension funds account for less than 5% of commodities indices. And significantly, many commodities (like some foodstuffs) have spiked over the last 12 months with no pension fund or commodity index fund participation.

The Commodity Futures Trading Commission (CTFC) has been grilling its members to increase trading transparency and appease regulators and government officials. Washington, DC is attempting to decipher what role institutional investors-including corporate and government pension funds, sovereign wealth funds, and endowments-are playing amid surging food and energy prices since last year.

Unfortunately, ongoing government and regulatory deliberations will probably result in higher exchange margin requirements and more transparency from commodity investors.

Commodity index funds and other speculators have played a role in driving prices higher-this is indisputably true. But this dynamic is far less powerful than basic supply and demand fundamentals that brought us to this historical bull market in the first place.

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