May 10, 2006

Tales of the Commodity Bubble

With the recent rise in oil and gasoline prices, and with the peddlers of gold coins starting to compete with for advertising spots on CNBC, lots of people are talking about the commodity bubble. Are commodities really in a bubble?

Who would you ask? Who would know?

Warren Buffet weighed in on the subject last weekend at the Berkshire Hathaway annual shareholders meeting in Omaha. Always a big fan of the world's second wealthiest man, known for his shrewd investment deals, plainspoken manner, and modest approach toward personal consumption, his message about commodities was not all that clear.

When asked about the commodity bubble, Mr. Buffet replied.

"I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans. But in metals and oil there's been a terrific [price] move. It's like most trends: At the beginning, it's driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant."

"Once a price history develops, and people hear that their neighbor made a lot of money on something, that impulse takes over, and we're seeing that in commodities and housing...Orgies tend to be wildest toward the end. It's like being Cinderella at the ball. You know that at midnight everything's going to turn back to pumpkins & mice. But you look around and say, 'one more dance,' and so does everyone else. The party does get to be more fun -- and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice." If you read this a couple times, you come away with the impression that he really didn't want to answer what was probably the direct question, "Is there a commodity bubble?"

First, it's a 'no' for agriculture, then a "terrific price move" for metals, followed by a discussion of the general characteristics of bubbles, ending up with a mixing of commodities and housing in the same sentence that also included more general discussion of bubbles.

One thing is sure, none of my neighbors are talking about all the money they're making in precious metals. We are probably years away from cocktail party chatter about junior mining companies. As an anonymous commenter remarked on yesterday's post:

I'm in a mining-centric city (Vancouver - many mining Co. Head Offices here) and still waiting to hear the first peep from a co-worker, relative or anyone else in a social setting about commodities (outside of whining about gas prices).

Not even on the radar.
We're still years away from commodities being in a Mom and Pop style bubble - with broad public participation. Maybe it's a little bubble-like for pension and hedge fund managers, but the party doesn't really begin until the really dumb money shows up.

Out of respect for Mr. Buffet, the obvious segue from the last paragraph will be resisted, and it will simply be noted that, according to this report, Berkshire Hathaway's 130 million ounce stash of silver, purchased in 1998, is gone.
At the company's shareholder meeting in Omaha, Nebraska on Saturday, Chairman Warren Buffett announced that the company has divested its silver holdings.
The source said Buffett didn't really talk about silver other than he sold it, but said he would rather hold businesses that have earnings.
Buffett said that Berkshire had not benefited from the particularly steep rise in silver prices.

"I bought it very early, I sold it very early. Other than that it was perfect," he joked.

The Sage of Omaha is still thought of very highly here - he's just having a hard time adapting to this "bubble economy" of the last ten years.

Turn on the TV

Over at CNBC, you get a distinctly different take on commodities depending on who's talking. Watching Kudlow & Company on CNBC, an occasional vice easily rationalized by the regular Thursday appearance of uber-blogger Barry Ritholtz, leads to the conclusion that there is a new leading indicator for the commodities bull market - Larry Kudlow.

When Larry says it's not a bubble - that's your cue to sell.

On last Thursday's show, Larry asks Herb Greenberg the obvious question.

Kudlow: I remember the internet bubble - this commodity thing reminds me of the internet bubble ... how does this feel to you? Has this got an internet bubble feel to it?

Greenberg: Well, it's more like it has the housing bubble feel to me, at least how it felt three years ago when I thought it was a bubble and so I'm afraid to say the same thing about this. I spent a good part of the day talking to a lot of people who are somehow involved in the commodities market, either in the pits or people who follow commodities for their hedge funds, and I seem to come away with nobody really feeling strongly that there's a bubble.

It's very interesting. They're not feeling that way in the pits, they're not feeling that way in the markets, because you see such demand Larry. There's clearly demand there, but, the caveat is there's clearly so much speculation now going into that - it's a great tug of war about what the dynamics of that market really are.
Later in the show, Ron Insana was asked about the commodity bubble. Somebody, please just say it's a bubble and make Larry happy.
Insana: There's a lot of reasons why commodities could be going up. Some are very good. The world economy is growing very rapidly, China 10.2 percent, India 7.4 percent, the U.S. almost 5 percent, so the demand for stuff, as Jim Grant likes to call it, is very, very strong and prices are going up.
The worry here is not that this is inidicative of strong economic growth, but that it is indicative of inflationary pressures that may be building in the worldwide economy, or that speculators have taken such large positions in commodities because there is so much money sloshing around the globe that we're ripe for a rather large pull-back.

I read one statistic today that suggested that hedge funds are controlling one billion barrels of oil - a lot of these charts have gone parabolic. Some hedge funds want to short the stuff, but every time they try, they get killed.

Kudlow: How about these new ETFs Ron? They're all piling in like a momentum play which means they're going to get their heads chopped off.

Insana: Investors or traders who have missed this rally, which by the way has been going on since 1998, they're piling in, maybe at the end, although some business people I talked to think this is a secular trend in commodity prices that may suffer an intermediate term correction.
Somebody call it a bubble! Right now! Barry Ritholtz!
Kudlow: Barry Ritholtz, are you ready to be a good contrarian, and step up to the plate and tell people to get out before their head gets chopped off?

Ritholtz: No. I'm going to tell you that historically, these commodity booms tend to last years and years, not five or six years, but ten or fifteen years - we're probably about half-way through this.
No luck this time. Maybe after a correction is underway it will be easier to get someone, anyone, to confirm the existence of this dangerous, yet very popular asset class that seems intent on chopping heads off.

A Reader Writes

Shortly thereafter, mail was received from reader Eric who was complaining about CNBC and their selective use of the word bubble.
The very same cable program that banned Bill Fleckenstein off their future programs, because he called them "bubbleheads". The same cable program that was forbidden to use the term "bubble" when the internet stocks went crashing...
It was at that time that something popped into my head - something about CNBC and the word bubble.

What was it?

Tivo was summoned to again replay these commodity segments from the CNBC show - something had worked its way into America's collective consciousness (including mine) and was being brought back to the surface by Eric's mail.

There it was.

A quick review of the commodity discussion revealed that the words COMMODITY BUBBLE had been conveniently displayed at the bottom of the screen during much of the discussion where Larry was begging for someone to call it just that.

Not "COMMODITY BUBBLE?" - with a question mark.

But, as a statement of fact - "COMMODITY BUBBLE".

Some more mail was exchanged with Eric, and we both had a couple of laughs at the thought of CNBC displaying INTERNET BUBBLE in big bold letters at the bottom of the screen a few years back when Mr. Fleckenstein was having such trouble getting on the air.

Keep an eye on Larry Kudlow - when he caves in - sell your gold.