Monday, March 3, 2008

Commodities Bubble Needs to Burst

....and the government can help this process.

The only good long investment in this current market is an investment in a commodity. Take your pick out of the bunch; whether mined, grown, or pumped, the price is skyrocketing.

I'm not sure that I have earned the credibility to call out professional analysts, but I can't believe that anyone who is still pumping commodities is a prudent investor. Below is the chart of wheat; I think it exemplifies how the current prices can't be justified as a normal movement.

Not too many tangible goods can increase in price fourfold in three years (or double in one). However, any agricultural product (or byproduct) has done this recently; corn, soybeans, soy oil, and other products have doubled or tripled in this same time frame.

Precious metals aren't too different; gold is setting new (non-inflation-adjusted) highs, while silver and platinum have enjoyed similar run-ups. Oil is also at historic highs, which is in turn increasing prices of natural gas, heating oil, and gasoline. Coal, the one non-renewable resource with hundreds of years of proven reserves, has also ballooned in price recently.

I can discern a few reasons for these increases:

  • Devaluation of the dollar
  • Mass-exodus from US equities
  • The ethanol hoax
  • Speculation
The dollar's sinking value simply makes globally-available goods more expensive. The cheapening of money by the Federal Reserve isn't happening; hopefully economic fears will pass over soon so that monetary policy can change.

The stock market performance is also leading to a search for alternative investments; many people think commodities are the answer. The only stocks currently performing are commodity stocks, as the underlying prices rise themselves.

The promotion of ethanol as a next-generation, better-than-oil fuel is a massive policy blunder. OK, it's a great PR opportunity to take a picture next to a pitchfork-holding farmer in the heartland; however, the same farmer will be cursing that politician in a decade when we're importing grain from Brazil. Someone made a great quote to this affect - "something is surely wrong with society when we burn our food as fuel." As the cost of dinner is increasing, how can anyone support the massive subsidies that allow a negligible amount of ethanol to enter the US energy system? I think if ethanol subsidies ended tomorrow, sure, some plants may shut down, and a few companies may go bust, but corn would return to a normal price, simultaneously decreasing inflation.

Lastly, speculation is clearly responsible for a big part of price appreciation. These people will get killed when the inevitable bust happens.

I'm not betting on an immediate burst; the analysts talking about support for oil at $100/barrel and $1500 gold have succeeded in establishing an acceptance of high prices. But eventually, rationality will return, and people shorting commodities (or stocks/ETFs) will be the winners.

I'm long DUG (Ultrashort Oil & Gas) right now; the energy price swings are a little more short-term than the grains and metals. It's a small position, because it's not worth it to bet against the fear, speculation, and madness driving prices. If key policy (Fed, ethanol, etc) is changed, prices could change soon - otherwise, prices may stay high in the immediate... but wheat won't be above $10 forever.

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