Opinion: The Commodities Bubble Bursts

Copyright (c) 2012 Ted Hurlbut

There's been a lot written and reported about the dramatic drop in commodity prices in the last couple of weeks, and whether this represents a momentary pullback in a bullmarket runup to even higher commodity prices, or the bursting of an unsustainable bubble.

The runup in commodity prices has not left independent retailers unaffected. Increases in cotton prices have impacted apparel retailers, increases in gold and silver has impacted jewelers and the surge in crude and gasoline prices has impacted everyone.

So are commodity prices going to continue to moderate, or are the going to continue their charge after a brief, momentary pause? My take is that commodity prices are likely to maintain these new lower levels for a while, and then trend gradually downward.

There's been a number of suggestions as to what caused the sudden drop in commodity prices last week, and they all suggest to me a bursting of a bubble. The president asking the attorney general to investigate the commodity markets for trading irregularities. The CME raising the margin requirements on silver trades dramatically after a stunning and unprecedented runup in the price of silver. The European Central Bank suggesting that interest rates on the euro would be increased toward the end of this year rather than in the next month or so. The killing of Osama bin Laden, suggesting that the U.S. still has the wherewithal to affect events in the Middle East, and that the risk premium on Middle Eastern crude has been significantly overcooked.

But what strikes me more than anything is the dramatic rebound in the value of the dollar. The core issue seems to be the way the currency markets have been viewing the current Federal Reserve policy of quantitative easing. The Fed has been buying Treasuries in an effort to further stimulate the economy. This seemed to set off a speculative frenzy among investors opposed to the Fed policy, investors who believe the Fed should be pulling back to prevent inflation rather than trying to prime the pump. They've been figuring on significant inflation down the road, betting on commodities and against the dollar. It's been a herd mentality, all heading in the same direction.

But betting against the Fed is risky business. From where I sit, the Fed looks good. When the recession hit, the velocity of money (the rate at which it circulates through the economy) slowed dramatically, and has only increased begrudgingly since. In fact, cash seems to have pooled on corporate balance sheets, and, by the way, in all manner of investment accounts, looking for the next big thing to invest in (hello commodities). The herd now seems to be breaking up. The dollar is rising and commodities are moderating. It's likely to be hard to pull that pack-mentality back together again. With that, I think inflation looks relatively tame, at least until the economy starts picking up steam, money starts circulating more quickly as lending and business investment pick up, and unemployment begins to drop more significantly.

All of this is good news for independent retailers. Most significantly, look for gas prices to begin to head back down soon. For many retailers, the year has gotten off to a reasonably good start. The bursting of the commodities bubble should help keep that momentum going.

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