A Bubble in Commodity Prices? We Think Not
We often hear speculation about whether commodity prices are in a bubble and whether investors should take their money off the table before the bubble bursts.
We disagree.
There are essential reasons that commodities have risen in price and why they will maintain current price trends, as well as risks to maintaining that price level. First, let’s look at some recent commentary about price levels.
The following is just a sampling of recent commentary. As can be seem, there is a general mood of price increases.
January 13, 2011 GFMS released Gold Survey 2010 Expecting that towards the summer prices could start to move materially higher, with gold possibly breaking through $1,500 at that stage
January 10, 2011 Mineweb The experts have spoken! This year’s gold price high will be $1632, silver $38.36, platinum $2015 and palladium $993.35 – or so the experts who have been prepared to set out their forecasts for all to see in this year’s London Bullion Market Association price forecasting competition (Forecast 2011) predict on average.
January 10, 20 11 Stonecap Forecasting higher Gold and Silver prices than ten-year averages. We believe precious metal prices will remain above ten-year averages for the foreseeable future. Fundamental drivers for the price are the lack of new supply and continued strong demand. We see a lack of new gold and silver supply coming onto the market in the next two years.
Commodity Price Stability
Prices rise or fall for specific reasons, including market sentiment and market movers.
Currently demand is strong. Demand in the Western economies is starting to pick up as sectors improve. The weakness in the US dollar is fueling a recovery of sorts and demand which was almost nothing during the worst of the meltdown, is now evident. Replenishment of inventories is continuing.
Demand from BRIC Continues.
The almost incomprehensible increase in middle class population in these countries provide a continuing and increasing demand for goods, which creates a demand for commodities.
The regular announcements from China about restricting this commodity or that rare earth are because their internal demand is creating more and more need.
As the economies improve, confidence improves, and speculators return to the market. Today’s comments are not a commentary about whether this is good or bad. It is simply a fact.
Lastly in this short list, is the continuing effect of the meltdown, where so many suppliers went under, or lost some of their capacity to supply. This created shortages, as it always does, and we now are facing these shortages. Although this factor is slight so far, it will continue to increase in importance.
Risks to Current Price Levels
The most important factors causing the price escalations, are also the greatest risk factors.
Risk – Low Interest Rates
The central banks and world governments are trying to maintain very low interest rates in order to stimulate economic recovery and growth. A few decades ago inflation got out of hand and it essentially was beaten by enormous rises in interest rates. Should this scenario again occur, commodity prices will suffer greatly.
At this time, we will use Japan as the example. In spite of very low rates for a very long time, inflation has not been a factor. We think in the near future, inflation will not be a major factor in any major market.
Risk – Demand from China. India et al
Demand from newly developing countries comes in waves as their economies react to internal and external events. We are confident that economic waves from the BRIC countries will vary, but those increasingly demanding populations for goods and services are not going to disappear. With greater and lesser demand from time to time, the basic demand will remain and prices will remain stable as a result.
Risk – The Double Dip Recession, or Return of a Major Economic Fall
As we have said for some time now, the economic recovery continues. There are bad moments, and some bad statistics, but that is the way it works. Real estate values in some areas continue to fall, but the incredible over-demand previously created will take time to work its way out.
This Cycle
It will take time, but this cycle is at the bottom, or now slightly above the bottom and the next cycle is starting. It will gain momentum as time passes, and as confidence grows. Commodity prices follow a combination of demand and speculation. Both factors increase in importance as the economy increases.
