Commodities Prices Take a Tumble

As I wrote in a previous blog post about the price of gold, gold appears to be a crowded trade.  The following quote from a Bloomberg article today confirms my suspicions, and generalizes the notion to take in other commodities as well, such as oil and silver:

“It’s panic,” said Michael Shaoul, chairman of Marketfield Asset Management, which oversees $1 billion in New York. 'You have those super crowded trades. Now you’re in liquidation mode. There’s nothing to do with weak U.S. economic data. It’s not a global financial crisis. It’s a classic liquidation move in a crowded trade.' "

The full article is on Bloomberg, a free Internet web site devoted to investments:

http://www.bloomberg.com/news/2011-05-05/oil-metals-fall-as-slowing-global-growth-drags-down-stocks-euro-climbs.html

As I have mentioned to clients many times, "the cure for high prices is high prices".  The meaning:  when prices get too high, counterbalancing takes place.  In the case of commodity price inflation, the following tends to occur:  (1.) economies slow down as commodity prices cause businesses and consumers/employees to cut back on purchases of other goods and services reducing overall demand, (2.) consumers of the commodity will try to find substitutes for the commodity whose price has risen (again, reducing demand), (3.) consumers of the commodity will cut back on their purchases, since their dollars only stretch so far (reducing demand yet again), and (4.)  as the price of the commodity goes up, producers of that commodity tend to produce more to take advantage of the price spike.  In other words, high prices cause an increase in supply of the "hot commodity", alleviating the imbalance between those who would like to buy the commodity, and those who sell the commodity.


In the case of commodities today, part of the price rise should be blamed on emerging market economies that are demanding more and more of everything, as their economies grow and develop.  The other part of the recent price spikes that we have seen in commodities is speculators driving up prices by buying commodities that they really do not need.  Instead, speculators are buying commodities because they believe that the price momentum will continue to rise.  Again, this is the bigger fool theory:  bigger fools buy a product not because they need it or because the price is a bargain; rather, they buy because they believe that there is a bigger fool out there who will buy the product at an even higher price.