Is commodity market a bubble? By Shan Saeed
The recovery is questionable and investors should buy on setbacks in the market, but the risk is rising since the Federal Reserve could make a serious mistake going forward by going for QE3 and creating asset bubble especially in the commodities market.
Fundamentally, commodities were higher because of the Fed’s policy of quantitative easing [QE], basically printing dollars to buy up Treasury bonds in order to keep interest rates low making commodities buying cheaper and inflating demand.
Expectations of roaring U.S. inflation [ 5%] and a rapid decline in the value of the U.S. dollar [ 51% in the last 27 years] has led investors to snap up commodities such as gold and silver, agri-commodities, base metals and energy market pushing prices to absolute, if not yet real, records and pressuring oil to well above levels one would expect in a slow U.S. economy. *Financialization of commodities has commenced with financial investors taking on huge positions in the commodities market to benefit from rising prices.
* Source: Bank of Japan-March-2011
I think the Federal Reserve is now in a situation where it's on the verge of a policy error. Printing more money is not going to give confidence to the economy. I think it has let QE go on too long already. QE was the right policy when the US economy suffered from a lack of liquidity. That is not the problem now. There is plenty of liquidity in the economy. But no confidence which is the main driver for the US economy.
Banking lending is available to those who should be able to access it. Any new effort to make money available, or a blunder in removing the props to the economy, could create bigger problems.
Liquidity is not an issue in the market. Quantitative easing going on for so long is now in the situation where it has pushed the dollar below its fundamental valuation and has created a bubble in commodities.
Gold opened Monday back above $1,500 an ounce and silver recovered some ground lost after it collapsed 31 percent in a week from 2-7 May-2011. The dollar stabilized at around 75 on the U.S. Dollar Index, above its low point of 70 against a basket of global currencies.
The sharp decline in commodity values last week were warning signs investor should take seriously. Pull back and consolidation can take place very rapidly. The drop was typical of an asset bubble, but the setbacks in commodity prices were not enough to unwind their inflated values.
My strategic analysis for investors is that investors now should be underweight material stocks, miners, and commodities, calling the rush into commodities can be very volatile/risky. In fact, rising U.S. interest rates could trigger a “very bad time” for commodities in the next 12 months, since in it will suddenly become expensive to hold non-interest bearing assets. However, with low confidence in the US ECONOMY, will commodities take a pull back going forward is a big question? I think commodities will continue its upsurge.
I'm hoping that we're towards the end of QE on June 30, 2011. I'm hoping there isn't a QE3. If that isn't the case, then it will prove transitory. If they carry on easing, we have a problem. I think QE3 will enter the market by end of this year.
Disclaimer:
This is just a research piece and not an investment advice. Investors/readers are encouraged to execute their own due diligence before making any strategic investment or entering into financial contract or obligation. All financial transactions carry a RISK
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