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Commodity Bubbles



August 29, 2013 – Comments (1)

Board: Macro Economics

Author: WendyBG

Commodity bubbles have been a feature of capitalism since the 1600s. (cf. "Manias, Panics and Crashes"). Each bubble comes with a convincing back-story.

We probably all remember the oil bubble of 2007, whose spike was characteristic of bubbles. The "peak oil" story, supported by leveraged speculators, caused a rapid run-up of the oil price to $140 per barrel. The bubble then burst, causing the oil price to plummet to $40 per barrel.

Commodity prices (except for bubbles) are determined by supply and demand. The cost of production affects the profitability, which affects investment (or disinvestment) to change the supply. Demand is highly elastic. Consumers may conserve the commodity (quick response) or invest in capital goods to switch to a different, less expensive source (e.g. change from gasoline to natural gas -- a slower response).

Currently, oil and gas prices are not quite as high as they were during the 2007 bubble, but they are much higher than they were 10 years ago.

At the same time, natural gas prices have dropped to roughly the same range as 10 years ago.

All of the energy sources have been in a stable range since the end of the 2009 recession. There is no sign of price bubbles or sudden collapse.

The price of copper, silver and gold tell a different story.

"Doctor Copper" is a building material which reflects the state of the world economy. Since the recovery from the 2009 recession, the price of copper has been range-bound.

Silver is partly industrial and partly a precious metal (store of value). Gold is almost entirely a store of value (other than the small amount used as jewelry).

Both silver and gold prices entered a bubble, which burst in 2011. The trend since then has been downward, with some noise. It is impossible to say when and if these prices will stabilize because the noise (daily ups and downs) disguises the trend.

Precious metal prices were lowest when stock returns were good. If the economy continues to grow in a stable trend with low inflation and no crises, precious metal prices will continue to fall. If the economy begins to grow faster, inflation will probably rise and the story for gold may strengthen. There is no data showing this at present. Velocity and the multiplier are very low and inflation averaged below 2% in 2013.

The "back story" for a rising gold price is long-term speculation about rapidly rising inflation in the future. This will only happen if the fiscal and monetary stimulus enters consumer hands more rapidly than the growth in productivity, leading to an excess of demand over supply. With the Fed tapering and the Federal deficit declining, fiscal and monetary stimulus will decline, not increase. There is no sign that the economy will suddenly perk up, increasing velocity and the multiplier dramatically.

Corn prices suddenly dropped in July 2013. Food writer Michael Pollan says that corn is part of 70% of the U.S. food supply (including livestock feed). I don't know what caused the sudden drop in corn prices, but perhaps it is connected with a decline in corn-based ethanol?

Households are sensitive to the cost of gasoline, heating fuel and food. The underlying commodity prices appear to be stable at this time.


Crude Oil Prices: West Texas Intermediate

Conventional Gasoline Prices: New York Harbor, Regular

US Midgrade All Formulations Gas Price

US All Grades All Formulations Gas Price

US Diesel Sales Price

Natural Gas Price: Henry Hub, LA

No. 2 Heating Oil Prices: New York Harbor

Propane Prices: Mont Belvieu, Texas

CBOE Crude Oil ETF Volatility Index is low.

Gold volatility is spiking as the price begins to rise.

CBOE Gold ETF Volatility Index$COPPER,...

1 Comments – Post Your Own

#1) On August 29, 2013 at 5:55 PM, miteycasey (28.85) wrote:

Corn is going to have one of it's best harvests in years. That's part of the reason for it's drop.

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