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Barron's cover story notes commodity bull markets are being fuelled by retail speculators, while seasoned commercial players are betting on a downturn.

Here's the gist of Barron's short case:

The CFTC (Commodity Futures Trading Commission), due to the relatively limited capacity of commodity markets and the ease with which they can be moved, puts limits on the sizes of speculators positions. However, commodity ETFs, pools and mutual funds sidestep this limitation through complex deals that have them buying and selling off-market through a conduit called the International Swaps and Derivatives Association [ISDA]. The CFTC is aware of the situation, and is gathering on Apr. 22 "to hear firsthand from participants to ensure that the exchanges are functioning properly." An idea of just how deep-rooted the problem is: ETFs, mutual funds and commodity pools seem to account for a full 60% of all bullish commodity positions.

Commodity bull Jim Rogers notes that there are about 70,000 mutual funds in the world, and only about 50 that invest in commodities. He thinks the speculative bubble has a few years to go. But looking at the 'smart money' -- farmers and others who actually trade in and use the physical commodities -- tells a different story. Net commercial shorts are 30% higher than a previous record.

Factors that could burst the bubble:

  • Even the slightest hint of a China slowdown (much of the bullish outlook is due to the perception of an 'insatiable' China).
  • A U.S. recession.
  • A stronger dollar (commodities are dollar-denominated).
  • A stronger stock market, leading people to put money back into stocks. (Or, conversely, a weaker market that sees traders liquidating commodity longs to meet margin calls. Barron's doesn't mention this, but it got some mileage when gold and oil dived suddenly a couple weeks ago.)
  • The CFTC changing its exemption of position limits on index funds.

Société Générale analyst Albert Edwards says the commodity bubble is "nonsense on stilts," and is sure prices will unravel before year-end. Barron's says prices could drop 30% as speculators retreat.

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Here's what some Seeking Alpha contributors have recently said on the topic:

  • Stephen Frankola agrees with Barron's. He says the commodity bubble needs to burst. While it's impossible to say when, rationality will return, and shorts will be the winners.
  • Andy Abraham calls today's market a dot-commodity bubble. "We all know that investors love to chase returns," he writes. "Many of these charts look uncomfortably familiar, like housing prices in California a few years ago and the technology-stock heavy Nasdaq composite index in the late 1990s. We know those bubbles ended badly for investors chasing returns. Remember the dot-com bubble? Don't get caught up in the dot-commodity bubble."
  • Meanwhile, Tim Iacono ridicules commodity shorts who are ready to celebrate every time the markets seem ready to turn. He likens the Fed talking the markets down to British police, who, without firearms, stop and yell at escaping criminals, "STOP! Or I'll yell STOP again!"
  • Bob Zieger says high commodity prices, particularly oil and byproducts, are here to stay.
  • Finally, Roger Nusbaum says he's always believed in commodity exposure, provided it's moderate. He says some exposure adds "a little zig to my stock market zag," but stops short of calling it a "bet on commodities." He doesn't give an exact formula for exposure, but says he's not comfortable with anything close to the 20% often batted around.

Iacono also has a superb post that analyses the various commodity ETFs and their holdings. Big funds include DBA, SLV, DBC, USO, GLD and IAU.

Source: Get Out of Commodities - Barron's