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Don't Get Caught in the Dot Commodity Bubble

by: Andy Abraham March 10, 2008 | about stocks: DBC / DJP / GCC / GSC / GSG    

Andy Abraham

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Wheat up 32 percent. Cocoa up 38 percent. Coal up 56 percent. Platinum up 41 percent.

How about the Rogers commodity index? Up. Or the GSCI Index? All this can make your noise bleed in such short periods of time.

Are we in a period of super rampant inflation?

Or could it be a Dot Commodity period?

Is it really about Chinese consumers storming food markets even though they are experiencing the worst inflation since 1997. This I can tell you: 100% it isn’t about a drought driving corn above $4 a bushel, the way it did in 1980.

It might be more plausible that a flood of investment money has swamped the commodities markets and driven prices to nose bleed levels. Evidence of the overwhelming nature of this came recently in the Minneapolis wheat pit, where prices jumped more than $4 a bushel in one day.

Honestly I do not know, but if the world is heading for, at best, a recession, then is it really all that logical that these prices keep on moving? Maybe yes, maybe no. Regardless, one always needs to consider the risks and how to protect capital.

Possibly one explanation is exchange-traded commodity funds, a relatively new product which pools investor dollars much like mutual funds that buy stocks, except that these buy commodities futures contracts. Some focus on specific markets while others spread the investments across many commodities as index funds, such as the GSCI or the Rodgers Index.

Such funds have become staggeringly popular. Financial advisers tap them as a way to diversify clients’ portfolios, adding some zest to equity holdings that seem increasingly to zag at the same time. Commodity funds are also attracting money because they’re soaring.

We all know that investors love to chase returns.

One needs to remember that the commodity markets can be extremely volatile, and buying just an index could be an accident waiting to happen. All one has to do is look at the SP Index funds in Oct 2002, down almost 49%. After seeing so much in my investment career, I would not be all that surprised to see these commodity index fundsgo through a severe rough period.

Many of these charts look uncomfortably familiar, like housing prices in California a few years ago and the technology-stock heavy Nasdaq composite index in the late 1990s.

We know those bubbles ended badly for investors chasing returns. Remember the Dot Com bubble? Don't get caught up in the Dot Commodity bubble.

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This article has 10 comments:

  •  
    Mar 10 06:33 AM
    It is good to see Wall of Worry articles.
    We should have more of these.
    Reply
  •  
    Mar 10 06:52 AM
    Sure it may be a bit frothy now but long term how are we going to support our farms when the basic input costs in the form of energy are rising? I think it's fairly straightforward, rising energy costs lead to rising input costs for other commodities. If each year we find as much as we energy as we consume I'd be less bullish on commodities but so far we're finding insignificant amounts compared to what is used and they definitely aren't offsetting production declines.
    Reply
  •  
    Mar 10 08:05 AM
    Are commodities markets more volatile than stock markets? It's the commonly-stated position but are they really?
    Reply
  •  
    Mar 10 11:07 AM
    Commodity prices have been soft for the past week or so. Soybeans, one of the biggest upside movers, is lock limit down today -- 3 days in a row. Corn, too. Cotton also. Long-term, I expect commodity prices to be well-supported, but commodities over the past week have shown considerable price weakness. Even gold is down today for the 3rd day in a row.
    Reply
  •  
    Mar 10 01:42 PM
    We are so far from this being a commodities bubble, it ain't even funny. When half the world's population is industrializing, you can bet the basic building blocks are going to go up in price. Who cares about short term fluctuation's in commodities price. Be happy you may have an opportunity to buy them on sale. The question is how much is copper going to cost in 5 to 10 years from now while China and India (nearly 3 billion people) upgrade their lifestyles to be more on par with the US? Do we have large stock piles of commodities lying around just waiting to bring the price down? Has US environmental laws allowed mining to actually keep large stock piles of materials? Does the price of oil indicate we are awash in black gold? Wake up! This is not a US market story anymore. Its about a very tight supply of materials from the rapidly growing demand from China, India, the Middle East, and even Russia. If you think we are in a bubble, you are definitely not looking beyond your borders.
    Reply
  •  
    Mar 10 05:51 PM
    I agree with theRealBull. There is a growing demand, supply cannot keep up. For some commodities, there is even talk of 'peak' (peak oil, peak gold). Where are the new major oil discoveries ? Even if there is one, it take years before the first drops will reach the markets. Similarly, it takes years before new mines finally start producing. Of course, nothing goes straight up; there will always be corrections in bull markets (even 50%, look at the dow or other indices).
    Reply
  •  
    Mar 10 10:50 PM
    We are in a commodity bull market, its true. Could it be a bubble? YES. But only Time will tell.
    We were in a stock bull market, could that bubble have popped? YES. But only Time will tell.

    Its very telling that some investors wear blinders, regurgitating Wall St. spin without any critical thinking, balance or skepticism.

    Many calling the current six years-and-counting commodity "bubble" would never admit the same for stocks. That double-standard is called BIAS. Many stock-pushers hate gold - they hated it 6 years ago, they hate it more now! They get daffier & daffier as commodities rise and the Stock Market declines - proving the gold-haters WRONG, month-by-month, year in, year out!

    Invest without emotion, but don't drink anyone's Kool-Aid, either.
    Reply
  •  
    Mar 11 04:29 PM
    The only people claiming commodities are in a bubble are those that weren't smart enough to buy them in the past decade.

    They were too busy doubling down on financials, housing stocks, and tech stocks ... oil is in a bubble at $45, oil is in a bubble at $60...oil will never hit $100. Enough said.
    Reply
  •  
    Mar 15 02:08 PM
    There were people everywhere during the housing boom saying prices would always continue to go up - "its not a bubble, its demand for a limited supply." The limited supply of agriculture argument eerily similar. Has there been such a global shift in demand in less than a year? It looks more like the parabolic growth of the housing bubble. With so few places to put money, and the economy continuing to deteriorate, hopefully it will last for some time to come. But hardly sustainable.
    Reply
  •  
    Sep 17 10:35 AM
    With hindsight your article has proven its worth. Commodity bubble has burst.
    Reply
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