There has been a significant amount of talk about bubbles in the commodity market. Most of this commentary is unclear and poorly thought through. There is no clear definition of what many of these people define as a bubble. Just because prices increase quickly does not mean that there is a bubble. Just because prices fall after a prolonged rise does not mean that a bubble has burst.
Lets' just take a simple case of how markets operate. I like to use Stein's Law, "If something cannot go on forever, it will stop." Commdity prices cannot go up forever. We know because we have see these spikes before. They are often associated with fundamentals. Any prolonged increase in price will cause a response in supply and demand. The speed and type of response doe not create a bubble. In the case of commodities, there are a number of forces at work.
First, there is the increase in demand which has been a direct result of rising incomes in many merging markets. There is also demand that is inelastic to price. The demand for gasoline is inelastic to price. Only with a significant increase from say $2 to $4 a gallon has there begun a change in demand. Even now the process is slow because to change consumption often requires a capital investment, a new car with higher gas mileage. In the case of food such as meat, the demand is a function of income levels. With the rise in emerging market incomes, there has been a corresponding increase in protein demand. This will only abate if real income falls.
Second, commodity supply is inelastic. So the world wants more oil, let's just drill another well and suck it into a pipeline. Unfortunately, that is not the way supply increases. The Saudis may not be able to increase production regardless of how much they are asked by Western heads of state. They may not have the capacity and increasing the pull from the fields may actually do more harm in the long-run. For the case of grains, planting only occurs once year for many crops so there is limited amount of time to make a change in supply. You cannot add a third shift for production. Also the cost of inputs in the production process have increased with the both the price of energy and fertilizer increasing by healthy amounts.
A good op-ed article called "The Rich Get Hungrier" in the New York Times by Noble prize winner Amartya Sen a leading development economist provides another perspective on the commodity issue.
http://www.nytimes.com/2008/05/28/opinion/28sen.html?ex=1369627200&en=73a97d22b4ea2c62&ei=5124&partner=permalink&exprod=permalink
Is some of the increase in price due to momentum players who have got on the commodity bandwagon? Of course. This is often the nature of commodity markets which have a high percentage of technical traders. But that is that the same as saying that there is a wild bubble. We will see prices move lower. The volatility suggests that the range of potential prices is wide. Prices will also adjust with demand and supply but that is not the result of bubbles popping.
Lets' just take a simple case of how markets operate. I like to use Stein's Law, "If something cannot go on forever, it will stop." Commdity prices cannot go up forever. We know because we have see these spikes before. They are often associated with fundamentals. Any prolonged increase in price will cause a response in supply and demand. The speed and type of response doe not create a bubble. In the case of commodities, there are a number of forces at work.
First, there is the increase in demand which has been a direct result of rising incomes in many merging markets. There is also demand that is inelastic to price. The demand for gasoline is inelastic to price. Only with a significant increase from say $2 to $4 a gallon has there begun a change in demand. Even now the process is slow because to change consumption often requires a capital investment, a new car with higher gas mileage. In the case of food such as meat, the demand is a function of income levels. With the rise in emerging market incomes, there has been a corresponding increase in protein demand. This will only abate if real income falls.
Second, commodity supply is inelastic. So the world wants more oil, let's just drill another well and suck it into a pipeline. Unfortunately, that is not the way supply increases. The Saudis may not be able to increase production regardless of how much they are asked by Western heads of state. They may not have the capacity and increasing the pull from the fields may actually do more harm in the long-run. For the case of grains, planting only occurs once year for many crops so there is limited amount of time to make a change in supply. You cannot add a third shift for production. Also the cost of inputs in the production process have increased with the both the price of energy and fertilizer increasing by healthy amounts.
A good op-ed article called "The Rich Get Hungrier" in the New York Times by Noble prize winner Amartya Sen a leading development economist provides another perspective on the commodity issue.
http://www.nytimes.com/2008/05/28/opinion/28sen.html?ex=1369627200&en=73a97d22b4ea2c62&ei=5124&partner=permalink&exprod=permalink
Is some of the increase in price due to momentum players who have got on the commodity bandwagon? Of course. This is often the nature of commodity markets which have a high percentage of technical traders. But that is that the same as saying that there is a wild bubble. We will see prices move lower. The volatility suggests that the range of potential prices is wide. Prices will also adjust with demand and supply but that is not the result of bubbles popping.
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