The Commodities Stampede: Is the Smart Money Heading for the Exit

As one can see by looking at the 3-year commodity charts below, commodity prices have been rising at a steep rate. As an investor, one should ask, are the increases occurring due to fundamental factors like demand or are prices rising due to speculation? Maybe it is less speculation and more the fact that individual investors are jumping on board this train near the tail end of the commodity price boom. One can't easily predict if the end of the commodity boom will turn out like the end of the technology boom that began in 2000. On the other hand, investors should be knowledgeable of the bets of the so called smart money.

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The Barron's issue that was released today has a story titled, Commodities: Who's Behind the Boom? ($). The article notes:

"...Thanks to the proliferation of mutual funds and exchange-traded funds tied to commodities indexes, speculative buying has gone way beyond anything the domestic commodities markets have ever seen. By one estimate, index funds right now account for 40% of all bullish bets on commodities. The speculative juices are even more plentiful -- nearly 60% of bullish positions -- if you count the bets placed by traditional commodity "pools."

Here's the problem: The speculators' bullishness may be way overdone, in the process lifting prices far above fair value. If the speculators were to follow the commercial players -- the farmers, the food processors, the energy producers and others who trade daily in the physical commodities -- they'd be heading for the exits. For right now, the commercial players are betting on price declines more heavily than ever before, says independent analyst Steve Briese.

For example, in the 17 commodities that make up the Continuous Commodity Index, net short positions by the commercials have been running more than 30% higher than their previous net-short record, in March 2004.

It seems commodity speculators are betting that prices will wane. The below chart details the historically high short positions of the commercial traders. In the end, over valuation alone may not burst this apparent bubble, but an investor needs to know prices may be ahead of fundamental demand.

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Source:
Commodities: Who's Behind the Boom? ($)
Barron's
By: Gene Epstein
March 31, 2008
http://online.barrons.com/article/SB120674485506173053.html?mod=9_0002_b_this_weeks_magazine_home_top