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Page 1 of 2 The big question facing commodity investors is obvious: Is the recent run-up in commodities prices a speculative bubble or is it a natural expression of supply and demand? It is the same question we've been asking for more than a year. To a large extent, nothing else matters. We decided to take a fresh ... and perhaps a definitive ... look at the issue. First, a definition of the term "bubble." The most elegant one I've seen was from "The New Palgrave Dictionary of Economics" (with thanks to Justin Lahart): a bubble "refers to asset prices that exceed an asset's fundamental value because current owners believe they can resell the asset at an even higher price." It seems almost axiomatic; a market buoyed by belief. It's a kind of capitalist religious fervor. Yes, We Are Given the recent pullback in commodity prices, you could easily argue that commodity prices were and perhaps still are overvalued, a position many analysts take. The numbers can support their arguments. Oil is down 30% off its July high. Gold is down 14% (after clawing its way back from being down 24% last week). Aluminum has lost around 22%. Such numbers lead to article with titles like "The commodities bubble has burst," the premise being that it's all over, and we're just waiting for overweight operatics. No, We're Not If you get past the Chicken Littles and look at some of the underlying fundamentals, however, you find that for many commodities, supply is tight and demand is growing. Famed commodities guru Jim Rogers is still bullish on commodities, if his latest remarks in India are any indication. (Do keep in mind that he was hired to talk at the opening of a commodity equity fund.) Back at the end of August, he wrote an article titled "Why commodity prices are not done rising yet," in which he lays out a simplified version of his super-cycle theory. The main points of his theory remain intact: no new oil fields, continued Asian demand. He touches on the fact that there has only been one new lead mine opened in the past 25 years. Another analyst, Dan Amoss, comments that the recent correction has been in part fueled directly by failures in the financial sector, with big commodity fund managers like Ospraie Management forced to sell out positions to raise capital: The commodity sector wipeout of the last two months has obliterated any froth or excess. And now, prices may overshoot to the downside. One thing is clear; fear and forced selling are driving the commodity markets right now...not underlying fundamentals. Amoss also notes that low commodity prices may result in reduced production of certain commodities if/when the price of the commodity drops below the cost of production. No company is going to continue mining if they are losing money to do so. In other words, the pullback is itself a driver of supply - or the lack thereof. Maybe Fence sitters should find fellowship in the slightly scary comments by CFTC Commissioner Michael V. Dunn on September 5: Based upon our staff's surveillance and research, we can tell a pretty good story about why market fundamentals have been, at least partly, behind the price increases in agricultural and energy markets. But, it is undeniable that there have been large flows of new investment into our markets. The real question here is scale. Each one of these investments might be relatively small, but what happens when the trickle becomes a flood? Essentially, the argument goes, instead of pricing just supply and demand factors, commodity markets have begun to price commodities' value as an asset class as well, creating a price distortion or possibly even a bubble.
So what is the answer? The answer is ... we are not quite sure. Considering our current knowledge, I doubt it is possible to come up with a definitive answer one way or another at this time - markets and market behavior are simply too complex and our understanding is still evolving. [Emphasis mine.] Scary, but let's face it, pretty damned honest. What Do The Data Say? With all these differing viewpoints - all from very smart people - who should we believe? Rather than playing pick-your-pundit, let's look at some data. During a recent interview with HAI, one of our favorite commodity analysts - Jeff Saut of Raymond James - suggested we perform a simple comparison. Saut said that we should plot the value of the Commodities Research Bureau index (CRB) against the S&P 500 over a long time horizon. So let's do that. First, here's a look at each index's long-term performance.
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