Wikinvest Wire

Does the commodities bubble really need to burst?

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 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.
But that's just it!

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.

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12 comments:

little larry sellers said...

These articles used to anger me, but now I just find them amusing. Mainstream writers are forced to walk into a trap of their own making, since admitting that it's natural for commodities to rise against an ever-weakening dollar is heresy. No one may challenge the "inflation is only 4%!" mantra. These writers get the joy of attaching their names to this garbage every few weeks. It seems to be the duty of the foot soldiers to fall on their swords, constantly proclaiming the premenant death of commodities until no one takes them seriously anymore.

But I suppose the appearance of these stories and the authors' willingness to be wrong so often shouldn't surprise any of us. After all, one of the main perks of siding with the Wall St line is that you get an infinite number of mulligans. Their only problem is that some of the public seems to be getting wise to this ruse, judging by the posts I've read recently on a variety of message boards. Eventually, the mainstream financial media will be taken as seriously as Pravda was in the Soviet Union.

SPECTRE of Deflation said...

Money rolling out of commodities and into the market. The smart money knows when it's time to leave the party before the drunks hit the road.

me said...

I'm with you Tim. Corn plantings down 8%. Not enough rice. If you tend to think in terms of a US-centric world then you might buy the bubble, but as world leadership rotates to Asia, then as China and India build and grow their infrastructure, commodities demand will continue to be strong.

As for smart money, I really don't know what that means. Right now none of them are looking very smart to me. Banks? Maybe hedge funds"Cerebus, how is that Chrysler working out for you?

Commodities are finite, period. Do a little research and you will find a great cases to be made for peak oil and how Saudi production continues to go down.

Long term investors, not speculators are driving this. Overlooked was the fact in that article that the little guys were holding fast.

Tim said...

David Gaffen at the WSJ MarketBeat blog put it best this A.M.:

Premarket: More Write-downs? Let’s Party!

Swiss banking giant UBS AG Monday announced massive write-downs related to bad debt exposure, and its chairman is stepping down. Naturally, this is license for the markets to rally and for investors to buy up securities firms en masse.

In premarket trading shares of UBS gained 8.6%, according to Archipelago. U.S. bank Citigroup Inc. was up 4.5% in premarket action, while brokerage giants Goldman Sachs Group and Lehman Brothers Holdings gained 2.6% and 5.1%, respectively. This, even after Lehman said it plans on raising nearly $3.5 billion in the capital markets, and after credit-rating agency Fitch lowered its outlook on the company.

smurf99 said...

A year ago commodities seemed to roll in tandem with the broader stock market. I believe you commented back then that commodities would probably diverge from the stock market one day... perhaps this latest correction is a divergence? Beginning to feel like a battle now, commodities vs stocks... who's gonna win?

JD said...

Anyone who has been around the block a couple times will recognize this for what it is ---- a chance to buy at lower prices. Has anything really changed? Is there any reason to think the dollar is going to heal itself? Don't forget about all the looming entitlement problems ---- we'll probably be coming out of the current recession just when those problems start to hit.

Tim said...

smurf:

Historically, when times are good, stocks and commodities both rise, but, during the early part of recessions, commodities rise as stocks fall. Toward the end of recessions, stocks tend to rise as commodities fall, so it all comes down to how long you think the current recession might run.

Of course, these generalities don't really account for whether you are in a secular bull market for stocks of commodities.

Anonymous said...

Foreigners who make stuff that other foreigners want to buy gain buying power for their currency.

Foreigners with Currency Buying Power (remember this phrase) can bid up prices for foodstuffs, clothstuff, grains, industrial metals, farm land, mines.

Farmers want Currency Buying Power (CBP) for their stuff. Patriotism and Nationalism goes out the window. CBP means farmers can get Mag Wheels for their tractors and buy more prostitutes, er, hookers.

Economics is a phony rhetorical logic that twists the also misused logic of Statistics.

What happened in the last taxation period has little bearing as to what happens today. You cannot predict the future.

Statistics is a historical logic not a predictive one.

Farmers have human nature as we do. Highest bidder bidding with the highest valued thing to trade is what all folks want, even farmers.

fat_tail_rider said...

Guys,

I agree with all of this long term (spectre of deflation's comments excepted), but I was out of GLD and JJA when they first broke their 50 day MAs and so far I am not regretting it. Short-term I am agnostic on the hyperinflation/deflation debate. In the absence of belief, I have to defer to the price action.

Re "speculators," better a hard-assets speculator than a "value" investor buying low-growth Dow stocks at PEs in 20s.

little larry sellers,

Nice little riff!

Aaron Krowne said...

Epstein's premise is simply wrong.

The ETF's create no fundamental upside bias -- anyone can short an ETF as well as they can buy it long (especially, ahem, speculators).

What is really going on is what Tim himself indicated... most people new to the market are going long to better preserve their wealth. Because there don't seem to be many other safe havens left out there.

If the rules are bent in favor of the commercials, and we see them take "hopeful" (or malicious) positions in an attempt to supress prices, we will get shortages. This is extremely dangerous when it comes to consumable commodities. Fire is being played with here.

JJ2000426 said...

Tim:

I have posted a complete rebuffal to Gene Epstein's commodity bubble theory. Read it here:

http://stockology.blogspot.com/2008/03/investing-in-resource-constrained-world.html

JJ2000426 said...

Sorry the above link was not clickable.

Click this link

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