Posted on 03/10/2008 4:52:50 PM PDT by kiriath_jearim
Commodities were at the centre of one of the earliest known financial bubbles – the tulip mania that hit the Netherlands in the 17th century.
The price of the flower was lifted by huge investment demand to a peak of 1,500 guilders a pound in February 1637 – equivalent to what a master carpenter made in about four years. It had seen a tenfold increase in the space of two months and was trading at a level not supported by demand-supply fundamentals.
Amid record costs, demand for tulip bulbs soon evaporated and prices crashed.
Fast-forward about 400 years and some analysts claim that the commodities market is in the middle of another bubble, as the prices of crude oil, copper, wheat and coffee reach multi-decade highs while these products attract record financial investments.
Tobias Levkovich, Citigroup’s chief US strategist, holds this view. He says in a recent report that commodities, particularly gold, are looking like a “bubble prospect” as “easy money and speculative juices combine to drive prices unsustainably higher”.
But whether commodities have truly become the third and last bubble of the past decade – after the dotcom bubble, which burst in 2001, and last year’s subprime housing market – is open to debate.
Kevin Norrish, at Barclays Capital, disagrees with the view of a bubble. “The price rise is fundamentally driven,” he says, pointing to robust demand, lagging supply in spite of record prices for key raw materials, and jumping production costs.
John Kemp, an economist at Sempra Metals, a London-based commodities brokerage, says a bubble has probably emerged as investors pile into raw materials on the expectation that prices will continue to rise.
“It will be a mistake to assume that commodities prices will rise further without doing damage to the economy and triggering a response from central banks worried about inflation,” Mr Kemp says.
On Monday crude oil prices hit a fresh all-time high at $107.77 a barrel, up nearly 80 per cent since early 2007.
In spite of disagreements, analysts concur that investor interest in commodities is skyrocketing, and this prompts questions about what is behind the surge and what its impact has been on already record prices.
Jim Lennon, of Macquarie Bank in London, says investment into commodities indices has jumped from less than $10bn in 1998 to about $142bn last year.
Investors have poured an extra $30bn in the first two months of the year, potentially increasing total investments in commodities to up to $172bn, he says.
“By the end of 2008, total index fund investment could reach $190bn,” Mr Lennon adds.
Strong inflows have been matched by issues of new commodities exchange-traded products and medium-term notes, according to Barclays Capital. The bank says about 140 commodities-based products were launched last month, the highest ever and about double the number issued monthly in 2006 and 2007.
Institutional investors surveyed last week by Barclays Capital plan to continue to pour fresh money into commodities as they seek to diversify their portfolio – commodities usually rise when equities and bonds fall – and as a hedge against inflation.
Analysts worried about a bubble argue that investors who are shifting into commodities may not believe in the nascent asset class’s fundamentals, but rather see it as a way of parking money in a sector that is offering strong returns so far, at a moment of weak equities and bonds returns.
Others, however, say that the continued bet in commodities reflects the view that emerging economies growth will decouple from the economic slowdown in the US, which will lead to continued robust demand for raw materials.
Developing countries have generated the bulk of additional commodities demand. In the case of oil, for example, countries that are not in the Organisation for Economic Co-operation and Development accounted for 90 per cent of the increase in consumption between 2004 and 2008.
Ed Morse, of Lehman Brothers, says that while fund flows have certainly contributed to the market’s price rise, perhaps to unsustainable highs, “fundamentals on the supply side have tightened faster than demand has deteriorated”.
Among the supply disruptions, South Africa, Chile and China are suffering power interruptions, which have dented production of gold, platinum, copper and aluminium. Opec’s decision to cut crude oil production in late 2006 and last year have also contributed to low stocks, while extreme weather has dented agriculture inventories to levels not seen in some cases in the past 60 years.
The view that fundamentals are playing a bigger role is supported by the fact that prices of commodities in which financial speculators have insignificant or no influence, such as iron ore, freight or rice, have also risen strongly.
Iron ore’s price has risen nearly 350 per cent between 2003 and 2008. It is controlled de facto by three mining companies and a handful of steelmakers through annual, secretive negotiations. The increase is higher than that of commodities heavily exposed to financial speculators: in the same period gold rose 174 per cent and crude oil rose 250 per cent.
Analysts who say there is no bubble point out that commodities prices are not rising in tandem. While some raw materials such as oil and aluminium rose in the past two weeks, others, such as lean hogs, fell. And though tin prices escalated to record highs last year, the price of zinc plunged.
Bankers and hedge fund managers say the wave of commodities investment could give the false impression that spot commodities prices are being inflated by speculative bets.
Many of these new investors, they say, are looking at long-term commodity requirements, rather than short-term supply and demand balances, because these investors believe that industrialisation and urbanisation of emerging countries will result in a higher consumption of commodities in the long run.
The problem, Mr Morse explains, is that in the absence of long-term futures contracts, investors who are bullish about long-term prices can put their funds only in commodities indices and other products that invest in near-term contracts and, as a result, contribute to higher spot prices.
Reminds me of a scene in an old Western, whose name escapes me. Two guys are in a bar, but they’re broke, and haven’t any drinking money. One of the guys says, “watch this,” and pulls out a glass eye. The bar patrons get curious, and one of them offers money for it. The guy says, “I’ll auction it ... a dollar a chance. Thirty or so guys each buy a chance, and put the money in the guy’s hat. He draws a winner, and gives the winner the glass eye. Now he’s got thirty bucks, but he wants the glass eye back. By this time the winner is wondering what he’s going to do with the thing, and the guy walks up to him and says, “I’ll give you five bucks for it.” The deal is made. Now the two guys have $25, and the glass eye that they started with.
It boggles the mind.
Well, bankers and hedge fund managers aren't exactly the most reliable of authorities along about now. The falling dollar is a contributor, but it's not a false impression to say that speculation is fuelling commodities in no small part. The hot money has to go somewhere, and hey, we all need transportation, and to eat.
After driving down the economy since December 1st, oil is still going up.
Crude rises above $108 per barrel in New York
http://www.freerepublic.com/focus/f-news/1983481/posts
The “housing bubble” was a bubble, because the houses built were too expensive for the market. Oil is up due to worldwide demand that will increase as long as we live.
Yes. The same game was run in real estate during the ‘70s and ‘80s.
Even though this is reported in an English paper you might notice that commodities are priced in USD and commodities are bought worldwide ,, the devaluation of the dollar is a big part of the answer as is the fact that money is attracted to hot segments... the biggest factor however is the increased demand worldwide... this is a simple case of supply and demand ... I don’t see this as anything like tulip bulbs ,, nobody needs tulips ,, I need copper for wiring ,, I need Iron for a new car ,, I need aluminum for beer cans...
Worldwide demand will keep the market supported for quite a while ,, bubbles take time to develop and this isn’t anywhere near the end, it’s not even really a bubble, speculative appreciation but not a bubble .. When the US economy really turns to sh*t then these prices will drop and drop quickly..
yitbos
I guess that’s normal in a high-energy, dynamic economy with plenty of money and credit to be had. Stocks are pretty much the same way—the value of a stock on the stock exchange takes on a value completely unrelated to its value as a part-ownership in a corporation. In housing, the house takes on a value totally unrelated to its function as a dwelling place and the amenities it contains. What’s it going to be next? I have no doubt something else will emerge to manifest the same phenomenon.
“It is just happening faster than the others because commodities are a vastly smaller asset class.”
But what about currencies? Aren’t they traded on the futures market?
A person would be a fool to invest in commodities after the economy already started to slow....
except where nature’s weather has a hand
I suspect we're about to see a decrease in that demand. The US economy is decelerating quickly, and it's a mere formality to wait another quarter to declare a recession. There has in no sense been a "decoupling," no matter how much that concept has been ballyhooed in the world press. A recession in the US will lead to a recession or worse, in export economies dependent upon the US. The domestic stimulus is looking like too little, too late; Joe Sixpack is going to sock it away for the rainy days that appear to be coming, or spend it on groceries and gas. The whole thing has me extremely concerned. Our consumer-spending-driven "service" economy has yet to go through hard economic times, and the first impulse is to reign in the very spending that two thirds of our economy depends upon. This might be pie in the sky thinking, but maybe a coordinated, nationwide sales tax holiday, for a week or two, could be of benefit? Maybe even including fuel tax? I don't really know, but I do know that I've been takikng a hard look at my business overhead, personal spending and debt, and am looking to retrench and conserve cash where ever I can. I also know that I'm not alone in doing so.
>> “It will be a mistake to assume that commodities prices will rise further without doing damage to the economy and triggering a response from central banks worried about inflation,”
You don’t have to worry about Ben Bernanke worrying about inflation!
He’s in tight with the speculators. Plus, he has the brains of a bucket of moldy wheat mash.
Go Ben! Inflate our worries away.
Three-eights inch rigid copper pipe is a good commodity buy - doubled in price in one year. Eight foot sections are hidden easily between the footboard and headboard of your bed. They can also be nicely disguised in your basement as water pipes. You can install 15, maybe 20, copper pipes coming out of your water heater. A burglar, unless he’s a plumber on the side, won’t know the difference.
Oil use in the US is down 4% already YoY before the last $15/barrel runup and gasoline inventories are at record levels.
The chinese 9-12% YoY gains cannot last forever-—especially with the huge credit bubble over there.
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