Opening Position
January 2010
Happy New Year! Can we expect the bull run in commodities to continue into 2010, or will we see a burst in the commodity bubble? As long as emerging markets continue to grow, we are likely to see commodity prices continue to rise. Globally, industrial production is not the level it was in 2008, yet we are seeing rises in the prices of nickel, copper, energy, and other commodities. So clearly the current rise in commodity prices does not support the fundamentals of supply and demand, and that is a cause for concern. Money is flowing into commodities, which suggests that this rally is driven by the financial market, and that doesn’t come as a surprise. Given that the US dollar is currently in a slump, investors have an increased desire to diversify their assets. The price of commodities will continue to rise as long as there is the desire to buy. But isn’t this the formula for a bubble in the making? Not only that, wasn’t the market-driven rise in prices during the dotcom era the reason for that bubble? The same can be said for the most recent housing market collapse. The fundamentals during both burst bubbles did not support the rise in prices and we’re seeing it happen again, this time in the commodity markets.
I expected the recovery in the financial markets after the housing market collapse to take more time than it has. The various stimulus packages and incentives offered by the government certainly helped speed up the recovery. But if we were to see another asset bubble burst, will the lender of last resort still be willing to provide assistance? They have the power to create money, but they also have the power to prevent a bubble from bursting. In the current financial scenario, this would mean increasing interest rates or some sort of intervention, among various other options. But a rise in interest rates seems extremely unlikely, given that it could thwart the anemic growth we are seeing in the economy.
Regardless of what the Feds do, our concern should be protecting our capital. So keep a close eye on commodity prices. The run could go on for some time, but keep looking for signs that suggest an impending burst. Although it is good to know there is a lender of last resort, a bubble burst is still a bubble burst and it is bound to have negative effects on the value of your portfolio. Let past bubbles be lessons learned, so keep that in mind for 2010.
Jayanthi Gopalakrishnan, Editor