Increasingly sensible commodities "bubble" talk

Justin Lahart at the Wall Street Journal adds to the increasingly sensible talk about whether or not we are currently experiencing a "commodities bubble". This report is just one more reason why the Journal continues to be about the smartest newspaper around.

Commodity Prices Soar, But Are They in a Bubble?

After being buffeted by the dot-com, housing and credit bubbles -- not to mention the Chinese stock-market bubble -- there is a readiness by people on Wall Street and elsewhere to ascribe the term "bubble" to all sorts of things. But when it comes to commodities like crude oil and corn, that may be off the mark.
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In commodity markets, what is traded aren't physical commodities but contracts that are essentially bets on where prices will go, Harvard's Mr. Mankiw says. The final effect of the bets is limited unless they encourage speculation in the commodity itself -- encouraging, say, a coffee broker to warehouse coffee in hopes of getting a higher price later.

And that is what is happening, according to Mr. Mankiw's Harvard colleague Jeffrey Frankel, who says such speculative behavior is due to the sharp reduction in interest rates by the U.S. Federal Reserve. Low rates encourage commodity stockpiling, he says, by making it less attractive to sell commodities and put the proceeds into bonds and other debt instruments.

Critics of Mr. Frankel's theory say the expected rise in commodity inventories hasn't shown up. Mr. Frankel has acknowledged that, but also notes that perhaps oil producers are leaving those inventories in the ground. That could be one reason why the Saudi king rebuffed U.S. President George W. Bush's request for increased oil production earlier this month.

While appearing in this report only in passing, the possible connection between soaring energy prices and "peak oil" now shows up much more frequently than ever before in the financial media.

The odds didn't look too good a few months ago, but Matt Simmons' prediction that peak oil would be a bigger 2008 election issue than global warming is looking better with each passing week and with each $10 increase in the price of crude oil.