Stresses Seen at the Outer Surface of the Ballooning Commodities Complex

Matthew Boesler interviews L. Randall Wray regarding his views of the present commodities bubble:

We’ve discussed this topic before on Benzinga Radio, with respected market analysts like Dan Dicker (again) and Fadel Gheit–financialization of commodities markets. At issue: massive institutional inflows into paper commodities, which end up factoring into prices much more than, say, real supply and demand for the physical assets. The result? A bubble.

That term–bubble–gets thrown around pretty loosely these days, and it’s often a contentious issue, especially in the commodities

context. We’ve spoken to several others on Benzinga Radio, including successful investors like Jim Rogers and Marc Faber, who are outspoken advocates of the long commodities trade in the coming years. The question now, with evidence of a coming global slowdown increasingly in focus, is whether commodities will continue to outperform. The last few trading sessions, going back a week or so, certainly seem to have raised concerns.

Dr. Randy Wray, a respected economist at the University of Missouri, Kansas City, was commissioned by congressional offices in 2008 to look into the commodities markets as prices marched to record highs during early summer before crashing in July. He spoke with us on Benzinga Radio, raising several interesting points about the evolving dynamics of the commodities markets and the statistical significance of the change in prices we’ve seen over the last several years.

What piques your interest in the “commodities story” from a statistical perspective?

Of course, you can get a shortage of supply of some commodity. That happens. In the face of rising demand, the price can spike up really significantly, and that causes conservation of the use of it, substitution into some other commodity, and it will induce suppliers to supply more. So, some variability of commodity prices is not an unusual thing. There are 33 basic commodities, indexes that include the 25 most important ones, and if you look across the whole spectrum of commodities, what is unusual is that they are all just exploding together.

On the surface of it, that makes it appear to be pretty unlikely. Why would we have supply shortages across the full range of commodities and exploding demand across the full range of commodities? It causes you to look a little more closely and compare the increases of individual commodities’ prices with, say, the past century’s experience in each one of those. What you find is that individually, the price increases are extremely improbable. In the case of iron ore, it’s a once-in-a-two-million-year event.
Then, when you take the whole basket of commodities, and you think about how likely each one of these is, and multiply all of that together–what has happened just is impossible.

So, should we call it a “bubble?”

It is just the historically unprecedented rise of price of so many commodities all at one time. That makes you very suspicious that there might be something going on. Then, if you look at, say, the way that financial markets have changed, the way that laws have been changed that allow financial [players] to get in to commodities, you find out that there is actually an extremely close correlation in the timing of when financial markets were liberalized so that they could start speculating in commodities.

You match that with the flow of funds into commodities markets, and what you see is that the correlation is 100 percent. It matches absolutely perfectly with the flows from the financial sector into commodities. That is when this completely historic boom in prices began, and it continued up through fall of 2008, and then the flows began anew. They are back in, and we have another commodities price boom.