Tuesday, 26 October 2004

A bubble in commodities?

Bloomberg columnist Matthew Lynn thinks that the commodity "bubble" has burst. He gives several reasons in an article titled "Is the Commodity Price Bubble Finally Bursting?" yesterday:

One, prices have risen too far, too quickly. Whether you call it a bubble or a bull run depends on whether you want to choose a "boo" or "hurrah" word. Either way, there is no doubting that prices have had a dream run. The experience of the past few years teaches us that if it looks like a bubble, walks like a bubble, and squeaks like a bubble, then it probably is a sudden attack of "irrational exuberance."

Two, the global economy is expanding slower. The International Monetary Fund last month predicted that gross domestic product growth would drop to 4.3 percent in 2005 from 5 percent this year. Slower growth will lead to slacker demand for commodities.

Three, supply will start to increase. The commodity-price surge has led to more investment. Look at some of the companies staging initial public offerings. In the past two months, in London, there have been listings of Mercator Gold Plc, a gold exploration company; European Minerals Corp., which is developing gold and copper deposits in Kazakhstan; and Frontier Mining Plc, which explores for gold. Those are just three examples...

There is, perhaps, a fourth reason, as well. Global interest rates have been at record lows. There is a lot of loose money swilling about. That has to come out as inflation somewhere -- and in many instances it has shown up in commodity prices. Yet the period of ultra-low rates seems to be coming to a close.

I'm reluctant to call the rise in commodity prices a bubble. The rise of China -- which has largely fueled the run-up in commodity prices -- will continue for many more years to come. The surge in commodity prices has been in anticipation of that.

While prices may have pulled back recently, I think the long-term commodity bulls are more likely to be on the right side of the trade.

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