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Commodity Bubble?

See also:

• Double bubble trouble - two bubbles burst in the USA
• The next bubble to burst may be commodities in 2008
• internet bubble
• speculative asset bubbles (internet, housing, commodities)  
• underlying trends that are shaping our world today
• rising inflation worries 2008  ,  
• High Oil Prices  ,  
• Weak US dollar 

What is causing the 'commodities bubble?"

There are many theories:

1. speculators and commodity prices
2. loose monetary policy and commodity prices
3. see also our discussion on the end of cheap food where we outline many ideas

Following the "credit crunch"....

Industrial commodities may fall.   This is because industrial commodities rely strongly on the global construction business, which in turn is heavily dependent on the availability of credit.  If credit dries up for global construction (which will happen with the "credit crunch"), then it follows that global construction will slow...cutting into demand for industrial commodities.

Background to this trend:

Over the past decade, we have seen two major asset bubbles build up, and then burst. First we saw the internet bubble, and then the housing bubble...so, whats next? My guess is commodities.

But, the real question to ask is... why are we seeing these asset bubbles rise in the first place? What is the underlying root cause of these asset bubbles? If you look back to 1991, we saw a mild recession, and the fed cut interest rates to spur growth.

Then came the Asian crisis of 1997, and more economic stimulus. Lay this on top of already low interest rates as a result of China purchasing massive amounts of US treasuries (in effect, lending money very cheaply to the US), and you see that liquidity was building up. This excess financial liquidity, mixed with tech spending led to the first bubble, then a burst in 2001.

But, the underlying liquidity issue did not go away, and in fact it got worse. In response to the bubble bursting, the the following 2001 terrorist attacks, Enron scandal, etc... the Fed once again cut interest rates to spur the economy. The Chinese and other nations continued to lend the US money at extremely cheap rates, and again a liquidity pool built up... this time in the housing market as investors poured money into "safe assets" of homes.

Cheap borrowing costs led to the second asset bubble, which then burst in 2007, leading to a credit crisis around the world. But, in response to a slowing economy, the Fed once again cut interest rates.

Do you see a pattern here? Where do you think the excess liquidity will flow next time? Where is the next asset bubble (that will once again burst).

In earlly 2008, Im making the prediction that commodities are the next asset bubble, and we are on track for another bursting / crisis....what will be the impact on commodity dependent economies in Latin America?.... add your comments here

 see also

• speculative asset bubbles (internet, housing, commodities) 
• Asian countries fight to keep their currencies undervalued vs the dollar 
• Double bubble trouble - two bubbles burst in the USA 

Fundamentals:  Why are commodities going up and up (early 2008)?

1. Bet on China & emerging markets need for commodities
2. investors are running away from inflation....and buying "real goods"....so, fears of inflation are driving portfolio investors to invest in gold, and other commodities...which then drives more inflation...yikes!
3. US dollar is getting weaker, which has 2 effects:
   • all commodities (such as oil) that are priced globally in USD appear to be that much more expensive as the USD gets weaker.  But, in real terms, the price may not be appreciating that much!
   • investors in the US may be running way from paper investments (which are unattractive when the USD is getting weaker, and when inflation is rising).   They run from paper investments and seek out "safe" investments in physical goods, such as gold, silver, oil, etc... (all of which are spiking in early 2008).

Counter view:

1. Commodities are an indicator of worldwide economic strength, and therfore not a bubble.   Some analysts predicts that we are not really going into a recession....and they base this analysis on the high price of commodities.  They theorize that the commodity markets are not wrong, but in fact they are accurately predicting coming demand... and further economic expansion and growth.  This analysis is based heavily on the "efficient market" theory, and says that there are so many smart people trading in commodities, and they must see something that the recession "bears" do not.  In this analysis, the continuing high price of commodities is not a market bubble, that will burst, but rather a good indicator that the economy is not going into a recession, but rather is ready for another bull run.   Lets wait and see....
2. The US may go into recession, BUT, commodities are no longer directly dependent on the US economy (as they were in the 1970's).  So, the implication of this theory is good for Latin America, but really bad for the United States. 
   • Its good for Latin America because it means that (even though the US goes into recession), the commodity prices will not fall like a rock, and commodity exporting nations shouldnt hurt that much.  
   • Its bad for the US because (unlike the 1970's), a recession in the US wont drive down commodity prices, which wont help tame inflation, and set the stage for a rebound.  If commodities remain expensive, then a rebound in the US will be much more difficult (expecially if the US dollar remains weak, making imports such as oil that much more expensive).    On the other hand, a weak US dollar should help boost US exports (especially if foreign countries demand remains strong)....

Research needed:

correlation between a US recession and worldwide commodity prices

• how dependent on US demand are commodity prices
• If the US used to be the biggest buyer of commodities, but now its China, Europe, Japan, etc....
• Dierect analysis
  • how much commodities are imported directly into the US
  • how much commodities are consumed in the US
• Indirect analysis
  • how much (as%) of China's production is exported to the US?
  • What % of commodity usage from China is associated with US trade?
  • worldwide - what % of worldwide production is linked to the US (% of GDP consumed worldwide)
• With these statistics, we might begin to have a better understanding of the correlation between a US recession and worldwide commodity prices.

Potential Impact (if the "bubble" bursts)

1. very bad for countries that depend heavily on exports of commodities (such as many countries in Latin America, as well as Indonesia, and others)

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