Monday, March 31, 2008
So, it looks like the commodities bubble is bursting once again - for the second time in three weeks. This follows previous bursting episodes in mid-2006, late-2006, mid-2007, early-2008 and a few more mixed in between.
Today's bursting probably had a lot to do with the cover story at Barron's - Commodities: Who's behind the boom? - where Gene Epstein seems to think that record high prices for all sorts of hard assets - energy, precious metals, agricultural products, base metals - are bound to come back down to earth because they've been driven higher by "naive money" and "speculators" who, presumably, will turn tail and run at the first sign of trouble.
There's a case to be made for the impact of that crowd - they seem to have been involved with every market craze over the last couple decades since money and credit creation began accelerating back in the mid-1980s when you-know-who took the top spot at the Federal Reserve.
With oil over $100 per barrel and gold having surpassed $1,000 per ounce, commodities are certainly on their way to becoming a "craze".
But there's much, much more to what's been going on in commodity markets in recent years than just the involvement of wild-eyed "speculators" - a word that is, astonishingly, used some 21 times in this story.
Of course, if that term was being applied to the endowment fund managers at the Harvard and Yale, then heavy reliance on the word might be warranted. Few would likely consider these fund managers to be "speculating" - they would probably describe it as "portfolio diversification".
This would also likely be the case for the pension fund managers at the California Public Employees' Retirement System and the Pennsylvania Public School Employees' Retirement System who are both now plowing billions of dollars of teacher retirement money into commodities.
I too have more than a passing interest in commodity investments - a sizable portion of my net worth is invested in all sorts of "hard assets" and, aside from some small mining companies, this has nothing of a "speculative" feel to it.
Maybe at first, but not anymore.
It's more like protecting what I've got.
Harvard, Yale, CALPERS, and teachers in Pennsylvania probably feel the same way.
There's more to this story than meets the eye:
CHINA, AS EVERYONE KNOWS, IS A BIG FORCE IN THE extraordinary boom in commodities. Its voracious appetite for everything from corn and wheat to copper and oil has helped push up U.S. commodities prices by some 50% over the past 12 months.But that's just it!
But China is by no means the whole story. Speculators -- including small investors -- are also playing a huge role. Thanks to the proliferation of mutual funds and exchange-traded funds tied to commodities indexes, speculative buying has gone way beyond anything the domestic commodities markets have ever seen. By one estimate, index funds right now account for 40% of all bullish bets on commodities. The speculative juices are even more plentiful -- nearly 60% of bullish positions -- if you count the bets placed by traditional commodity "pools."
Index funds with buy-only strategies have had outsized influences on the market.
Here's the problem: The speculators' bullishness may be way overdone, in the process lifting prices far above fair value. If the speculators were to follow the commercial players -- the farmers, the food processors, the energy producers and others who trade daily in the physical commodities -- they'd be heading for the exits.
There's a whole new crowd of long-term, buy-and-hold type investors who have entered this sector for any number of reasons, none of which have to do with locking in a future delivery of oil or hedging their corn crop.
It has more to do with maintaining and growing an investment portfolio and, apparently T-bills just aren't doing the job anymore. Increasingly, it's the numerator in the price equation - the dollar - that is driving decisions to invest in commodities.
The article is worth reading in its entirety because a number of very good issues are raised on such topics as the impact all this new money is having on commodity exchanges, but, like many other economist-types who write about hard assets from time to time, the desire to be done with high commodity prices forever comes through loud and clear.
Not quite as bad as Stephen Frankola at Seeking Alpha when he wrote a piece with the self-explanatory title Commodities Bubble Needs to Burst, but definitely noticeable.
Jim Rogers probably put it best in the Barron's story when he "held out the prospect of a speculative bubble that could last for years."
Judging by the experience of the last few years, that looks like it might be the case.
Of course, that would mean that we will have to endure more stories like these.