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Is the Bubble of Commodities Going Down?

2012 Jun 27

 

It can be said that commodity bubble already went down. The prices of the most commodities have slumped significantly during several last months. But was there really a bubble? Yes, the prices have dropped, but it does not necessary means that there was a bubble. The volatility in commodities always has been very high and it is not surprising when prices decreases or increases strongly; and neither the significant drop nor the rise should be mistaken to a trend. 

 

So, why all these commodities are so volatile? The answer is simple: because a lot of investors are in this market. As I do not believe that commodities are real investments (we will talk about it later), I should say there are a lot of speculators (instead of investors) in this field. But that would not be completely true, because among the official numbers of investments that are made in commodities market there are a lot of companies that are using such investments for hedging, so, it is neither speculating, neither investing - it is pure goal of where proper commodities instruments can be used and should be used. 

 

What can we expect from now? Nobody knows where the prices will go from now exactly and maybe we should not talk of commodities as a whole – there are commodities of many different types and their price directions may split out in the future. But at first, is there really an investment bubble in commodity prices? It is possible in some specific segments, but commodity prices have strong support: increasing population over the world, increasing living standards in large poorer countries while limited supply at the same time. Those are true fundamental factors that have to force prices up for a really long term until something is going to change fundamentally (technological events). That will keep up the price during the long run; however, in the short period strong fluctuations in prices are inevitable.  

 

Yet, in the long run prices of commodities may go in different ways according to the type of it. I would separate few classes of commodities:

 

  • Regenerated commodities. Those are commodities that aren’t land resources and can be created by human. Simple example of those can be agriculture products. Such commodities will always have price limits because supply can be increased quite easily while new technologies are evolving, however, the prices of such commodities will be very sensitive on weather and other conditions during the short period. 
  • Non-regenerated, and not really consumed commodities. Such commodities normally are extracted from earth and can be used in many industries as electronics, machinery, jewelry or other. Examples of it: ferrous metals, precious metals and similar. The key idea about such metals is that these commodities are used but they are not really consumed because can be recycled – those metals do not disappear anywhere really, and if it will be worth it, all they are going to be recycled and it will increase the supply significantly. So we can say that this type of commodities also has obvious price limits.  
  • Non-regenerated but consumed commodities.  Those are commodities that are extracted from earth and being consumed totally and cannot be recycled again. The best example of such commodity is oil. Despite the fact that new reserves and resources consistently are found, sooner or later such resources are going to end. Naturally, before it happens prices will increase proportionally depending on availability of substitutes. Depending on many factors, price of such commodities may have no limits. 

 

But why would you worry about the prices of commodities? Commodities aren’t real investments and if you don’t have a need for a hedge, you should care about these only as much as they affect the total economy and the environment. But any commodity is not worth to invest in it directly – those are extremely volatile, do not generate any yield or cash flow, and have very unclear future. There is no reason to choose commodities as investments despite the fact that prices of those may increase. Better try to choose some horse betting; at least you will have some fun!

 

 

By Rokas Lukosius

 

Also read: 

Stocks and Commodities

Long term in investing

 





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