Is There A Commodities' Bubble?
You Bet - Sell Your Gold Already
Below are the main excerpts by Alan Kohler who publishes Eureka Report, a newsletter financially backed by Carnegie, Wylie & Co.There is now five times as much invested with hedge funds as when Long-Term Capital Management went bust in 1998 - a bit more than $US800 billionn. In 1998 the hedge fund losses totalled about 10%; a similar problem in 2006 would cost about $US80 billion. If this was the extent of the problem and it was isolated to hedge funds, it would be rocky but not a wreck. However, if it was associated with other problems, such as a mortgage crisis in the US sparked by a housing crunch, that would be a different matter. Between March 1 and May 11 the price of copper rose 80%, which is extremely silly. It was the largest of a collection of commodity price blow-offs driven by hedge funds and speculative long-only funds panic-buying in anticipation of a big upsurge in investor demand for metals on the back of the growth of exchange trade funds. Gold rose 40%, zinc 75%, nickel 45%, aluminium 38% and tin 20%. The damage caused by a generalised 25% commodity price correction, or more, would depend to some extent on the leverage of those funds caught long, and given the secrecy in which the hedge fund industry generally is shrouded it is impossible to know until the flag goes up. These jumps in price easily hints at excessive speculation but also the rise and rise of ETFs, but even buying for ETFs would generally involve actual listed stocks and not the physical commodity. The danger is if the commodity prices upswing also led investors to pick up related listed stocks. It's worth noting that the Australian market in general, including market leader BHP Billiton, did not really follow the copper rocketing prices past month. Middle-sized miners such as Zinifex, Oxiana, Hardman and Lihir did follow, which is why they fell about 10% per cent yesterday. Anyway, the commodity price bubble has been bearing all the hallmarks of the internet bubble of the late 90s: assets that don't make profits and don't pay dividends doubling and trebling in price because of a "game of pass the parcel to a bigger fool than me". It is the sort of game that must come to an end.
Morgan Stanley's Steve Roach says the commodity price surge is "off the charts" when compared with all those of the past. Over the past four years, The Journal of Commerce industrial gauge (which includes textiles, metals such as steel, copper, aluminum, nickel, zinc, lead, and tin, petroleum products including crude oil, benzene, and ethylene, plus a miscellaneous grouping of hides, plywood, rubber, red oak flooring and tallow) has increased by 53% - a sharper rise than that which occurred in any of the four previous periods of global recovery. "Moreover, as seen in real terms - scaling the JOC by the cumulative increase in the US headline CPI over the same periods - the current surge in commodity prices stands out as even more extreme," Roach says. "The real JOC is up 42% over the past four years - nearly double the 23% average gains that occurred in the two commodity booms of the 1970s and in sharp contrast with the relatively stable trends during the global growth cycles of the 1980s and 1990s."
But commodities are not the only assets that have been experiencing a bubble - the other is US dollar debt, as a result of the unsustainable American consumption binge, supported by the uneconomic purchases of US bonds by foreign central banks, especially in Asia. A gradual, long term decline of the US dollar has been underway since 2002, although for 12 months during 2005 it reversed because of the widening interest rate differential, as the Federal Reserve raised the US Fed funds rate at every meeting. More worrying, China is also tightening monetary policy and this week has allowed its currency to rise above the important eight yuan to the US dollar. It was that event that probably sparked the panic on commodity markets.
Due to the Chinese currency policy, Asian monetary policy has basically been locked into a dollar system. No Asian country wants to lose competitiveness to China, and thus they have been forced to maintain quasi-pegs to the dollar. The official removal of the dollar system means that the Asian dollar-based monetary system is now just about to self-destruct. Asian central banks have racked up unprecedented amounts of dollars, just as Europe and Japan took in excessive amounts of dollars … in the early 70s. A rush for the US dollar door again would be very bearish for Wall Street. The commodities correction, on the other hand, may be just what the resources sector needed.