Have commodities finally hit the wall?

I have been (incorrectly) forecasting that the commodities bubble was going to burst "any day now" for about three years now, causing me to miss out on a huge potential gain. Sigh. But, now, maybe commodities really are bumping into "the wall" and primed for a big fall. Commodities, especially gold, had been viewed as a safe haven relative to U.S. stocks, but yesterday gold actually fell sharply even as U.S. stock prices fell. That was unusual. Of course, a single day does not establish a change of trend. Still, it does give one pause. Then today I read an article in The New York Times by Diana Henriques entitled "Commodities: Latest Boom, Plentiful Risk" that tells us:

But this market, despite its glitter, offers risks of its own, including some dangerous weaknesses that are impairing the ability of regulators to police fraud and protect investors. Commodities are also vulnerable to the same worries affecting the rest of Wall Street, where on Wednesday the Dow Jones industrial average plunged almost 300 points, erasing more than two-thirds of Tuesday's steep gains.

Moreover, the biggest speculators and lenders in the commodities markets are some of the same giant hedge funds, commercial banks and brokerage houses that are caught in the stormy weather of the equity, housing and credit markets.

As in those markets, an evaporation of credit could force some large investors -- especially hedge funds speculating with lots of borrowed money -- to sell off their holdings, creating price swings that could affect a host of marketplace prices and wipe out small investors in just a few moments of trading.

"Right now is a very scary time" for commodity market regulators, said Michael Riess, a director of the International Precious Metals Institute, a consultant to commodities investors for more than 30 years. "It's not a question of overregulating or underregulating. It's a question of just being swamped by volume, volatility and a dramatic shift toward speculative interests."

That last phrase is key: "a dramatic shift toward speculative interests." The huge run-up in commodities prices is not about fundamentals or demand in India and China, but simply the fact that speculators have targeted commodities for their latest speculation, much as in the past dot-com stocks and home real estate were target by speculators. And we know how those movies ended.

The article closes with this cautionary characterization:

But some with experience in the commodities market remain nervous about the new money pouring in so quickly.

Commodity trading firms that have survived for any length of time have excellent risk-management skills, said Jeffrey M. Christian, managing director of the CPM Group, a research firm spun off from Goldman Sachs in 1986. Mr. Christian said he was less certain how the newcomers would deal with risk.

"You have the stupid money coming into the market now," he said last week. "And I think the smart money is beginning to get a little frightened about what the stupid money will do."

Yes, by all means watch out for where "the stupid money" is flowing.

Look for some undervalued markets to go after, not the markets that have been hot for many months if not years.

That said, I am still unable to predict with certainty that this time commodities really have hit the wall.

I think some of it may depend on whether the U.S. economy weakens a lot further. If so, commodities will fall like a rock. But if the U.S. economy continues to at least barely hang in there, hovering at the edge of recession, commodities speculators will likely continue to hover as well. In truth, I believe in the "hovering" economy more than a steep recession. Maybe in fact commodities will be our best indicator about the health of the U.S. economy.

One final thing I would say is that the U.S. economy always was, is now, and always will be much less like a well-oiled machine but much more like the old-fashioned Wild West. A boom here, a bust there, but always something interesting going on somewhere. Sometimes it is boom almost everywhere, but that is the exception rather than the norm. Only the media ever makes it seem as if the economy is booming (or busting) everywhere.

 -- Jack Krupansky