SAN FRANCISCO (MarketWatch) — The commodities bubble is dead. Long live the commodities bubble.
In fact, the plunge in prices of oil, gold, corn and other commodities over the past month could easily just be an overdue correction in prices after the impossible gains of the past 12 months. And long term, we can expect that most finite resources — like oil — to gain in prices as we use them up.
But long term, my SUV will be dead, so let’s focus on what’s happened this summer. After several years among the world’s best performing investments, commodities have hit one of their biggest slumps in a generation in the past few weeks.
Oil, which doubled in value over the past 12 months, is down about $30 a barrel from its $147 high, or a bit more than 20%. Gold, which traded above $1,000 an ounce in March, is now below $900. Agricultural commodities, whose price surges this past spring sent starvation warnings across the globe, have now fallen for several weeks running.
Yes, it’s the law of supply and demand. But not the way most of the pundits have argued. Take oil. Nothing’s really changed in supply over the past few months. And China and India – the two bugaboos of the natural resources demand equation — haven’t stopped importing. Yet prices are down 20%?
Everybody seems to be pointing to Americans driving less, and gasoline prices approaching $5 a gallon in places like California have borne this out, according to some statistical reports. But it wasn’t our driving more that caused oil prices to double in the past year.
…China, India, Middle East turmoil, fat Americans in big gas guzzlers. But the real supply/demand equation that has driven this rally has been the supply of investments in commodities vs. the demand from investors to buy them.
The fact is that the supply/demand equation has always been a convenient way to describe what is happening in commodities, with ready scapegoats always available. China, India, Middle East turmoil, fat Americans in big gas guzzlers. But the real supply/demand equation that has driven this rally has been the supply of investments in commodities vs. the demand from investors to buy them.
By comparison to currencies, bonds and stocks, these are small markets — even oil. They can easily be pushed around by walls of hot money. The amount of money flowing into commodities funds increased tenfold in the past three years, pushing up prices; just like the amount of money flowing into tech stocks in the late 1990s pushed up prices, and the amount of money flowing into U.S. houses — cheap money — pushed up prices. Even sovereign wealth funds, the so-called saviors of Wall Street, who stepped in to prop up tumbling investment bank stocks, have reportedly been buying commodities funds to push up the price of the commodity their governments are, in fact, selling.
Prices of oil, gold, corn, etc. have tended to move in lockstep recently, despite the fact that each commodity is affected by very different fundamentals. The single exception is that they all react to trading in the U.S. dollar, though that has been relatively flat to weak of late.
Now look at what happens when the hot money turns on commodities. A MarketWatch story earlier this week showed that last month, short positions by “non-commercial” investors — i.e. speculators — surpassed long positions for the first time in 17 months. See full story. Oil, of course, fell $16 a barrel in July.
And if the hot money can be believed, prices still have further to fall, as options contracts indicate that more money is now betting on declines than on a rebound. See full story.
Of course, it’s easy to argue that the hot money is chasing the direction of the oil prices, or betting the trend. It’s also easy to argue that it’s not fundamental supply and demand but “perceived” changes in supply and demand that are really driving prices. That is, of course, the basis of all speculation in the markets.
But try to find somebody who perceives that over the long run oil is going to get a lot cheaper, or that Wall Street is going to quickly recover from its worst credit crisis in 60 years. No, the recent Wall Street play on selling oil and buying financial stocks is simply that — a trading play — designed for short-term profits and driven by speculation. We’ll see who is buying financial stocks on Thursday after American International Group’s
results late Wednesday.
All of this is to say nothing of those who might be trying to actually manipulate prices, such as the two cases we’ve seen in the past few weeks brought by authorities in both the U.S. and the UK. Small cases, to be sure, but proof nonetheless that it can happen. Expect more of those as regulatory probes continue.
So let’s accept that the commodities boom is just like every other Wall Street fad, and that after swinging too far one way, the hot money pendulum has swung back the other way, at least temporarily. Commodities will continue to see rallies, and Wall Street will someday recover from its credit hangover.
The easy money in these bets, though, has already been made.
View more information: https://www.marketwatch.com/story/supply-and-demand-turned-upside-down-as-commodities-plunge