Hot Commodities: The Next Big Bubble?Written by Ben Treece | | firstname.lastname@example.org
Most everyone has heard the term “bubble” come up at some point or another when having a discussion regarding investing, however very few actually know what the term means or its significance.
A bubble is nothing more than a drastic over-valuation of an investment that is based almost entirely off of investor emotion or speculation and not supported by any raw economic data. They can form in any sector of the economy, from stocks and bonds to commodities to real estate. Bubbles pre-date any investment market and have been around ever since the times of barter and trade.
One of the best examples of a pre-NYSE bubble was Tulip Mania which popped in the mid 17th century. Tulips were in high demand because of their brilliant colors and their elegance compared to most other flowers. In 1637 a bulb buyer did not show up to pay for his purchase at auction, which caused a wave of fear in the tulip market, and after just a few weeks tulip bulbs were drawing 1/100th of what they had been at their all time high (Link).
There was also a bubble in stocks during the 1920’s that prefaced the Great Depression and of course everyone has heard or may even know someone who made a killing/lost a fortune during the epic Dot-Com Bubble at the turn of the century.
The question I pose to readers this week is this: Do you think there is a bubble brewing in the market, specifically commodities? Going off of the traditional definition that bubbles are created by an over-valuation driven off of investor emotion as opposed to economics, then it is a very fair argument to be making.
Most investors expose themselves to the commodities markets as a hedge against inflation, however as we have been saying for months, the inflation argument is a misnomer.
The pictured chart is M3, (from www.nowandfutures.com) which is equal to M2 plus deposits made at non-banking institutions, i.e. savings and loans institutions or money market funds. This calculation of money supply (in our own humble opinion) most accurately reflects money supply in the U.S. economy. As you can see, money supply has been declining drastically since 2008 and has actually been negative for the last 2 years, just recently turning positive. However since November of 2008 Gold has nearly doubled in value. One argument I often hear is that the declining value of the U.S. Dollar has caused gold to skyrocket. Well the USD is roughly (within a couple percent) at the same place it was in 2008, which is still low historically, but does not justify the take off in gold.
We believe that supply and demand has had more of an impact on commodities than economic factors have. Fear behind the USD collapsing and losing its position as the reserve currency of Earth and inflation taking off to the heavens has drawn investors’ money into metals, and a harsh winter has caused agricultural prices to shoot up as well. Domestic oil drilling is down (as you may have noticed at the pumps) and a large portion of what little corn has been produced this last year has been devoted to ethanol research instead of winding up on the grocery store shelves. Contrary to how I sound in this article, I have no problem with commodities. Investing in gold mining companies made our clients a lot of money … but we bought in back when gold was at $300 an ounce. Investors have to ask themselves; “Do I see that same upside potential today at $1500/ounce?”
The argument will persist for months and months I’m sure. Some will argue that with M3 breaking positive it is a sign of inflation which will cause commodities to skyrocket yet again, others will argue that the run-up in the last two years will result in a sell-off soon enough. Only time will tell who will come out on the winning side.
In the world of bubbles, one beast that everyone seems to be overlooking is bonds. With interest rates at all time lows, that makes bond prices at all time highs. And if there is anything that Tulip Mania has taught us, it’s that drastically high prices are unsustainable. Commodity holders be wary, but bond holders beware … you will be burned the minute interest rates begin to rise.
Ben Treece is a discretionary money manager with Treece Investment Advisory Corp and a stockbroker for Treece Financial Services Corp licensed with FINRA.