Commodities Bubble Needs to Burst

....and the government can help this process.

The only good long investment in this current market is an investment in a commodity. Take your pick out of the bunch; whether mined, grown, or pumped, the price is skyrocketing.

I'm not sure that I have earned the credibility to call out professional analysts, but I can't believe that anyone who is still pumping commodities is a prudent investor. Below is the chart of wheat; I think it exemplifies how the current prices can't be justified as a normal movement.

Not too many tangible goods can increase in price fourfold in three years (or double in one). However, any agricultural product (or byproduct) has done this recently; corn, soybeans, soy oil, and other products have doubled or tripled in this same time frame.

Precious metals aren't too different; gold is setting new (non-inflation-adjusted) highs, while silver and platinum have enjoyed similar run-ups. Oil is also at historic highs, which is in turn increasing prices of natural gas, heating oil, and gasoline. Coal, the one non-renewable resource with hundreds of years of proven reserves, has also ballooned in price recently.

I can discern a few reasons for these increases:

• Devaluation of the dollar
• Mass-exodus from US equities
• The ethanol hoax
• Speculation

The dollar's sinking value simply makes globally-available goods more expensive. The cheapening of money by the Federal Reserve isn't happening; hopefully economic fears will pass over soon so that monetary policy can change.

The stock market performance is also leading to a search for alternative investments; many people think commodities are the answer. The only stocks currently performing are commodity stocks, as the underlying prices rise themselves.

The promotion of ethanol as a next-generation, better-than-oil fuel is a massive policy blunder. OK, it's a great PR opportunity to take a picture next to a pitchfork-holding farmer in the heartland; however, the same farmer will be cursing that politician in a decade when we're importing grain from Brazil. Someone made a great quote to this affect - "something is surely wrong with society when we burn our food as fuel." As the cost of dinner is increasing, how can anyone support the massive subsidies that allow a negligible amount of ethanol to enter the US energy system? I think if ethanol subsidies ended tomorrow, sure, some plants may shut down, and a few companies may go bust, but corn would return to a normal price, simultaneously decreasing inflation.

Lastly, speculation is clearly responsible for a big part of price appreciation. These people will get killed when the inevitable bust happens.

I'm not betting on an immediate burst; the analysts talking about support for oil at $100/barrel and $1500 gold have succeeded in establishing an acceptance of high prices. But eventually, rationality will return, and people shorting commodities (or stocks/ETFs) will be the winners.

I'm long DUG (Ultrashort Oil & Gas) right now; the energy price swings are a little more short-term than the grains and metals. It's a small position, because it's not worth it to bet against the fear, speculation, and madness driving prices. If key policy (Fed, ethanol, etc) is changed, prices could change soon - otherwise, prices may stay high in the immediate... but wheat won't be above $10 forever.

Comments

[billb]

How and why should the government help this process? That wasn't real clear to me in the article. It's rare that government intervention helps much of anything. Although I do give them credit, the federal do-not-call list has made my evenings much more enjoyable at the house.

[Malkiel]

The runup in commodity prices reflects rapid decline in the dollar--where's the bubble here? It looks like we are simply paying the market price for the weakening dollar. I wouldn't expect to see these prices decline until the dollar picks up strength and investors relinquish their holdings into a buyer's market. Have I got it wrong that there's nothing abnormal about this market? If you want a useful government response, how about shoring up the dollar?

[Dude]

I bet you weren't too bearish on tech stock in 1999. I know where you are coming from & you aren't fooling anyone.

[dieuwer]

Look at commodity prices from another angle, say Zimbabwean dollars? I bet their prices would be even more parabolic to the upside.
Does that mean there is a bubble in commodities from a Zimbabwe stand point? Looks like it, but it's not; it's the Zimbabwean dollar that is rapidly depreciating! Same story with the US dollar...

[Stephjen]

Dude - in 1999 I was 10 years old, and not involved in the stock market yet... so maybe while I was building LEGOs you were losing 90% of your savings.

Dieuwer and Malkeil - I clearly state that the devaluation of the dollar is partly responsible for the increase in prices. However, that is not the sole reason for the parabolic increases.

Billb - I said that the government could help the problem by promoting a strong-dollar policy and eliminating ethanol subsidies.

[BlueSky&Sunshine]

One of the big reasons for the recent run up is basic supply and demand (not mentioned in the article). Easily produced crude oil is becoming more scarce while global demand keeps increasing. All the while the world's best reserves are becoming more concentrated in countries with inept, unstable, or even malevolent governments. Geopolitical risk, reserve mismanagement, and increasing consumption by exporting countries have become huge issues. Several very credible oil industry veterans have recently predicted oil price shocks of up to $300/bbl sometime in the next 10 years. "Peak Oil" is becoming a progressively more believable and near-term scenario. Agricultural commodities are bound to increase for the same reasons - there's a limited supply of farmland and steadily increasing if not unlimited demand. I agree that many commodities are in an unsustainable bubble TODAY. But beware. Just because something's overbought doesn't mean it can't go higher. I suspect the longterm trend for most commodities is up, especially oil, nat gas, and ag. Many "speculators"... may actually be true investors just trying to get in front of that trend.

[sbenard]

As a commodities trader, I agree that the market seem overbought. Still, the fundamentals appear to support high prices. From a technical standpoint, markets that rise this far this fast tend to burst and contract very quickly. I just feels overextended. I think a temporary retracement is due, followed by an even higher commodities market.

[daffy]

Buckwheat,

It appears to me that everyone here has blinder on. Blinders that only see what is happening in this country. What about China? What about India? What about all of those other countries coming on the fully industrialized nation grid? There are a lot of them. They need stuff, like copper, like food, like STEEL. Oh, they need oil too. Lots of it. Just because we come from a land of plenty, doesn't mean that these other countries do.

You make a good point, I just wish others were willing to look half as far.

[hugoh]

daffy,

It's true every country, specifically the rapidly developing ones, need supplies of all the commodities. Bear in mind, however, that their need did not develop over the past few months. While there are sound fundamental reasons to support higher commodity prices now than a few months ago, I cannot recall any market capable of supporting a parabolic price increase for long.

[Fed up]

If you can't see the commodities (including oil) bubble here, you didn't see the tech and housing bubbles either. Good luck getting out guys when the music stops. A good hard recession like in the good ole' days will make people shake their heads in wonder at these ridiculous prices. You know, like they do now about tech and housing prices at their peaks.

[maher]

Where do youget off sounding a false alarm - It can't be that you are ignorant of the facts. So what is the real reason for this article? Sounds kind of Kindergarten-ish to be sure.

[ben2k9]

If you study past commodity cycles, you'll find that they are much longer and much greater in magnitude than the one we're currently in. Any bull cycle is characterized with pullbacks along the way....but shorting commodities at this point is like standing in front of a train.

[Buzz]

The current environment is a commodity price bubble we have just entered into. This is the final stage/phase upwards in prices for most of the commodities. This will play out for the next few comming weeks.

A comparison to the stock bear market of 1974-1975 is lacking one huge fundamental play. The federal government is holding down the cost of borrowing today. Check how the bond markets are behaving. Long bonds are rising in value. If the fed played the bond market as they did in 1929, we would see a complete collapse of our economy, and a depression that would be worse than the one we called the 'great depression', because of the amount of leverage and loans outstanding, meaning all mortgages and loans. We are so close to seeing an economic disaster here, but luckily the federal reserve banking and Berancke acted out by doing the correct thing, holding and lowering rates, not raising them! They (feds), recogonize the price spiral in commodities as a short term speculative boom. Yes, there is a real demand behind all this putting real pressure on the prices of commodities, but speculative interest is floating the price upward like a rocket due to the speculative buying in long contracts overwheling the market balances in the trading pits. The real producers are ready to fill those contracts and dump the raw product into the commodity markets. They (Federal reserve), are willing to let the speculative pop run its course and play out. A blow off is emminent with the CRB index. The price move up in all of the commodities are at an unsustainable rate. You will see prices spike up wildly in gold, oil and other major commodity items, such as corn, wheat, gas, copper, and platinum, etc. As this occurs, the stock indexes will plummet like a rock in a spike down. Expect a 500 to 800 point down day for the Dow and a spike down of 100 to 250 points in the nasdaq. This will be the bottom of the stock markets (end of the current bear cycle), coupled in time with the end of the commodity bubble. Bonds will rally in price, and the interest rates will continue to drop to the lowest levels seen in history. It will be very interesting to watch. Withe the fed making the final rate relief move, the dollar will sink at first then reverse upwards for a 'V' bottom. The dollar, stocks and the commodity markets will all market reversals in a coupled fashion, possibly within the same week. Stock indexes are putting in the fifth wave (and final wave) of the bear market in stocks downward, and it should form as a 'V' bottom reversal.

Buzz


This should occur within the next one to up to four weeks.

It is like watching the same huge sum of speculative cash pushing each type of investment in a wild frenzy ride up in a spike. We saw it in the stock market in 1999 to 2000, check out the nasdaq long term historic chart. Then the money flowed into homes and land, pushing prices up wildly, now it is playing into the commodities. Prediction : Once the dust settles, expect a good end of year stock market comeback.

[User 165596]

that Buzz, is probably one of the astutest pieces of analysis i have read for a long long time. certainly agree about agro commodities. i am long puts on agro indices.

[Old F_rt]

"Dude - in 1999 I was 10 years old,"

You're 18 years old?!!!!! What do you know about something as complicated as economics? Trading for a big FIVE years and you write this? What was the last cycle you went through? Gimme a break!

There are food riots in Egypt. There is labor unrest in China and Vietnam due to high food prices. The rice market is almost seized up. Grain inventories are at 20 year lows. Mexicans protested the price of corn in the streets. Chinese motorists are lined up for gas and diesel. And these are just a few factors.

Dude, come back in ten or twelve years after you graduate and have learned something.

To seeking alpha, who screens these children?

[theobserver]

OMG food riots in egypt. Give me a break, people camped out and signed up for lotteries for houses and look where that led. These runups if you look at charts are nearly identical for tech stocks, then houses and now commodities. Wait until producers keep dumping supply on the market. The only difference is knowing when to pull out. If you've been in it for the long haul enjoy the profit, if you are buying now you are a fool. The psychology is the same, this time its different, the world is decoupling, the model is really different this time. All data shows that a some time, all trends revert to the mean and that can be painful.

[User 184668]

I think the Exchange Traded Funds are mostly to blame. Reference this article attached:

econdynamism.blogspot....

[skittles]

s.frankola - you shut that "dude" down. the "old fart" who posted above needs to take his alzheimer meds. he didn't even address his lecture to the right person.

today, i heard an analyst on cnbc commenting on what he called, "the emerging markets bubble." that "old fart" must have lived in the fifties, when teachers regarded america as the center of the universe, and charles darwin as the devil. although, the weakening dollar is partially responsible for the increase in the price of commodities, the primary culprit is the emerging BRIC middle class. technical analysis forbids commodities from breaching current support levels, regardless of the dollar. maybe the added pressure on commodities will result in technical innovation and a consequential increase in supply.

[commoditygal]

For many commodities there is clearly more demand than supply. Do we see demand for oil going anywhere? While some commodities may be slightly overvalued, in general commodities aren't going to be bursting anytime soon.

Another reference article on this: www.commoditynewscente...