Is there a commodities bubble?

I wrote the following post at the end of June, but forgot about it in my drafts folder. I guessed that there was a bubble in all commodities in the summer, and guessed that oil was inflated ~20% above “real value”. Looks like I was right: $145 at peak, now oil is around $106, down 27%. Corn and wheat are down over 20%. If I weren’t such a coward, I would be a rich investor by now.

[originally written 6/26/08] I was right about the Internet and housing bubbles, and now I’m going on the record saying there is a bubble in most commodities. Here’s how I think about financial manias:

  1. There’s never irrefutable hard evidence proving we’re in a bubble. If such evidence existed, then there wouldn’t be a bubble.
  2. If prices shoot up for a good reason, then there isn’t a bubble.
  3. Most investors in a bubble, including “professional” traders, are morons momentum players. If the chart shows a rapid rise, then they will jump on the gravy train hoping there’s one more sucker they can sell to before the whole thing collapses.

There has been lots of discussion about whether there is a speculative bubble in oil, but less discussion of other commodities. If you look at the charts for agriculture commodities at the Chicago Board of Trade, you’ll see the familiar hockey stick graph starting in late 2006. Everything was fine before that. So what event caused the price of everything to suddenly spike in 2006? Remember, this is before Australia’s drought reduced wheat supplies; before Bush called for increased ethanol supplies, thus reducing corn supplies. And it is long after everyone knew about 1 billion Chinese, 1 billion Indian, and another ~1 billion (Russia, Brazil, rest of Asia) consumers demanding more of every commodity.

On oil, I agree completely with Robert Reich’s post because he agrees with me. All commodities were hit by the same forces in 2006 (falling dollar, growing demand, lots of rich investors jumped into the market). If you look at this chart, the dollar fell relative to the euro in 2003 (and oil started moving up). It recovered a bit, and then it crashed again from 2006 to today. The main way to reduce prices in the US is for the dollar to recover. Agriculture prices will fall when supplies go up. There will not be a Malthusian catastrophe because most of the world’s farms are very low productivity vs. the West. They will improve and we’ll have plenty of food.

On the other hand, we might be getting closer to Peak Oil, but not in the sense that we’ll run out of the stuff. There’s probably lots of oil out there, but it’s much more costly to extract (offshore rigs, oil shale/sands). So the average cost of extraction will rise greatly from just $5/barrel for Saudi Arabia today ($15/barrel is the global average). Gas will never again fall below $3/gallon. There’s a bubble in the oil market, but it might only be ~20%.

My advice: Buy a plugin hybrid. Grow a vegetable garden. And don’t take investment advice from some random dude on the Internet.


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