Monday, April 28, 2008
What will prick the Commodities Bubble?
Despite weak economic indicators, rapidly deflating housing prices, and flat to negative consumer consumption commodity prices soar. Why? When looking at the price trending of commodities one can't help but notice that in the fall of 2007 rapid price appreciation starting taking place. Is it coincidence that as commodities roared fears of defaulting bond insurers, collapsing "bears", and credit market evaporation spread like wild fire? The correlation should be noted, but also take note that the commodities market has not corrected as equities market have seemed to heal (with the exception of tanking gold). Has fear of a housing market collapse driven investors to hold their wealth in terms of gold, oil, wheat, sugar, and aluminum? It couldn't be. Housing prices drive construction ....a major consumer of the economic nuts and bolts (i.e. commodities). It must be the fear that the dollars in our pockets have decayed in value faster than nearly all natural phenomena. U.S. Dollars, however, are not decaying at any rate, magnitude, or depth near that of appreciating commodities. Another interesting development (suspiciously timed with the boom in this market) is the creation of commodity linked Exchange Traded Funds. An interesting experiment was conducted in an undergraduate economic course I took in college. The professor created a "mock" economy with goods, services, and specific wealth allocated to each student. We then sprung into action, with instructions to act as economic agents. We placed bids for various valued items and services. We learned how price discrepancies were arbitraged by "rational economic agents". Then, the professor dramatically increased our means, by introducing credit. Prices, like our purchasing abilities soared. The rage in recent commodity prices are similar. A fundamental market shift has occurred by the introduction of new trading instruments to the novice speculator. Just as debt securitization turned risk taking activities on their head, Exchange Traded Funds have created a niche for commodities to be part of any "balanced" pension plan portfolio.