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.
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.
Randy,Do you have a link(s) about pension funds' exposure to commodities and commodity linked financial products? – as in data from official sources?
What is leverage ratio that pension funds are using when speculating in commodity complex? If they are responsibly managing risk/leverage, they can cover off price declines with cash and minimal asset sales. If they are "overleveraged" like investors were during the Nasdaq or housing bubble then precipitous downfall is much more likely.