Is the Commodities Market in a Bubble ?

Under investments

During the 19th and 20th century, the industrial revolution took place. Industrialization was considered to be synonymous with modernization and agriculture and related activities were frowned upon and considered to be primitive. Therefore, during this period, almost all of the economic resources available at the disposal of society were spent towards development of industry or towards building financial markets.

This has created a strange situation. The number of farms and farmers has been steadily declining whereas the number of people in the world has been steadily increasing. This went on for several decades and as a result, the world today is facing a food shortage. This under investment in agriculture and related industry is an irrefutable truth. However, at the present moment, it is being used as a back story to justify the unsustainable boom in commodities. It is true that the commodities are scarce. However, this scarcity has been greatly exaggerated.

The fall in commodity prices since 2015 has brought an end to almost two decades of incessant and unrequited price rise.

Debt Ridden Economic Policies

The western world has faced major economic upheavals in the past decade. The markets almost crashed and left many people homeless. In such scenarios, the pressure on the governments steadily mounted and they were forced to take some decisions which cannot be considered to be economically wise.

Almost all western countries in the world have lowered their interest rates. Many countries have maintained zero interest rates whereas other have crossed the line of absurdity and ventured into negative interest rates! Also, during the same time the United States has had three bouts of heavy duty currency expansion called the quantitative easing 1, 2 and 3 respectively. The use of QE helped them to solve their problems temporarily. Therefore such policies are likely to be emulated in Europe as well.

These economic policies cause the inflation to rise. Commodities are considered to be a hedge against inflation. Hence an expansionary monetary policy brings about a bull run in the commodities market. The problem is that this Bull Run has gotten out of hand in the past few years. Also, it is very unlikely that this Bull Run will continue in the future which is why the highly priced commodities are almost certainly in an economic bubble.

The US Dollar Decline

The United States has been at the forefront when it comes to debasing their currency. The dollar is said to have lost 94% of its value during the last century. The modern financial system prices all commodities in terms of the dollar. All important commodities are therefore priced in terms of the dollar. A decline in the price of the dollar appears to be a rise in the price of the underlying commodity.

The value of the US dollar seems to have hit rock bottom. It may not drop too much in the future. Hence, extrapolating the previous growth in commodity rates to create a basis for the future is likely to bring in an economic bubble which cannot be sustained by the fundamentals.

Financialization

The commodities markets were consumer markets. In the past five decades or so, commodities markets have been financialized. This means that commodities are now being used as alternate investment classes. Therefore people who want to diversify their stock and bond portfolio do so by investing in commodities. The development of commodities as an alternate source of investment has brought in a tsunami of additional capital. This additional capital is temporary in nature and may flow to a different asset class soon.

The development of financial markets and derivative instruments to manage commodities trading may have made life simpler for a few farmers and traders. However, it seems like it has created a bubble of epic proportions as it allows speculators to take massive positions even though they have no interest in the underlying.

The China India Story

The China India growth story has also been another major cause behind the boom in commodity markets. These two countries are rich in natural resources and are also the two largest populations in the world. As these countries have maintained sky high GDP growth rates, they have also used huge quantities of commodities. The unprecedented growth has been fuelled by oil, cement, food grains and energy ! Now the economies seem to have stabilized. In fact it is likely that these economies might soon be in decline. Also, China has grown significant internal capabilities and has in fact become a net exporter of some of these commodities.

Hence, the insatiable demand from these countries which was driving the commodities boom is likely to disappear soon. It would therefore not be inaccurate to state that the current prices of commodities are highly inflated.

Hoax Theories

Many critics believe that the world is facing a shortage of commodities. Terms like peak oil have been created to explain that oil is being produced and consumed at levels never seen before. While this is true, it is unlikely that the demand for any commodity will exceed the supply by such a huge margin that it would cause prices to rise even further. Developments in technology are causing the people to see through these hoax stories.

The commodities Bull Run might have ended. This can be gauged from the fact that oil has become stable at $40 per barrel! Expecting it to boom to over $100 again would be fundamentally wrong and would cause the investors to lose money.

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