Is it a bubble or not in '08 commodity markets?

by Morton Sosland
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At the time earlier in 2008 when food ingredient costs were soaring into the stratosphere, it was not unusual to read or hear how the escalation in wheat and other grain prices resulted from unfettered speculation as well as rapidly expanding investing in commodities as a new asset class. As climbing food prices caused more concern for sapping consumer purchasing power as well as for posing an inflationary threat, the most frequently heard remedy to check advancing food prices was governmental action to stop speculation and to apply the brakes to investing in commodity index funds. Before any of a number of suggested steps could be debated, much less implemented, the market itself tumbled precipitously in a manner that rivals, and may even outshine, the amazing gains to historic highs.

Still unanswered in the wake of this unparalleled roller-coaster experience food manufacturers have endured is to what extent the ride is due to supply-demand forces or whether it is just another bubble like the ones that have currently brought chaos to credit and finance. It was and still is the inclination of this page to argue that these price gyrations are driven mainly by a combination of depleted global supplies, including disappointing grain crops in more than a few major producing countries, combined with a dramatic surge in demand from emerging markets. China, India, Russia and Brazil stand as classic examples of countries that only a short time ago were not taken seriously as powerful markets for the same basic ingredients food manufacturers require in developed nations. The point also may be made that the collapse in prices once more proves the supply-demand adage that there is no cure for high prices like high prices. Production significantly increased in response to earlier markets climbs, weighing on prices in the way an increase in ending carryovers traditionally causes weakness.

In making this case for fundamental influences, sight must not be lost of the one unique aspect of the 2008 commodity market moves. That is the way that almost every single commodity, whether a crop like wheat and corn, a mineral like copper and gold, a soft commodity like cotton and sugar or an energy source like crude oil and natural gas, tended to move in nearly parallel fashion. The astounding price collapse in the month of October alone provides a striking case for the bubble theory. Even though each of the commodities has its own separate supply-demand forces, price movements in the past month as well as year to date are similar. Thus the Dow Jones–AIG Commodity Index, made up of 19 commodities, was down 28.65% in the first 10 months of 2008, while grains alone were off 28.48% for the same period. The energy sector dropped 29.56% for the year through October and precious metals lagged a bit, being down 20.23%. Many of these commodities fell in October by percentages that set records.

Such uniformity among commodity declines has to reflect the way that investors and hedge funds, to name the two most commonly cited participants, have fled from this asset class. Data would indicate that index funds have imploded in a way that justifies one analyst naming the month "Blacktober." Yet, even after paying heed to the evidence that what happened earlier represented a bubble not unlike the manias that have characterized many of these same markets over centuries, it is hard, if not impossible, to argue that the price peaks registered some months ago were unjustified. Without the real incentive these prices provided, plantings for 2008 would never have soared. Perhaps a point does exist where dealings in commodities could become so excessive as to overwhelm fundamental forces. Yet, futures contract revisions offer solutions that would make unnecessary steps designed to impose restraints. After all, these markets and their users like food manufacturers almost always manage to benefit from expanding participation.

This article can also be found in the digital edition of Food Business News, November 25, 2008, starting on Page 9. Click here to search that archive.

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