Commodity bubble may be next to burst

Commodity bubble may be next to burst
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First Published: Mon, Mar 24 2008. 11 02 PM IST
Updated: Tue, Mar 25 2008. 08 20 AM IST
The commodity bubble could be the next to burst. Oil prices had one of their sharpest falls ever on Wednesday, to $104 (Rs4,206.80 then) a barrel. Oil has fallen 11% from a record high last week and, in fact, traded below $100 a barrel on 19 March. And other markets seem to be tottering off their recent highs.
On 17 March, commodities dropped by the most ever recorded. The UBS Bloomberg gauge fell 4.6%, the largest decline since October 1997, when the data starts. The Reuters/Jefferies CRB Index plunged the most since at least 1956.
Commodities had kept soaring despite the credit crunch. The prices of oil, copper, iron ore and foodstuffs have risen to all-time record levels in the last few months. The contrast with equities, let alone housing and credit, has been stark.
Bulls argue that demand from rapidly developing countries such as China and India justifies the high prices. But, in reality, commodities have become the last refuge for speculators as other bubbles have popped.
Rapidly growing demand only explains why prices stay high enough to fund new investment in wells and mines. For oil, the cost is somewhere between $40 and $60 a barrel. The story is similar in most other commodities.
Speculation explains much of the gap. Commodity traders until now have enjoyed low margin requirements—meaning they can leverage their bets to the hilt.
It’s too early to say that the top is history. But US demand is weakening and the Chinese authorities are trying to rein in domestic growth.
Potentially more important, the credit crunch could finally catch up with the commodity speculators. The signs are still pretty tentative, but stories are beginning to circulate about commodity hedge funds being squeezed. If prices start to fall, margin requirements will be raised and the market could be sucked into the same sort of vicious spiral that has devastated credit.
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First Published: Mon, Mar 24 2008. 11 02 PM IST
More Topics: Oil Prices | China | India | Copper | Iron Ore |