Commodity Bubble by Morgan Stanley

“In the midst of a slightly subpar upturn in global growth, a low-inflation world is experiencing the sharpest run-up in commodity prices in modern history”

What’s new

Asset bubbles have dominated financial market experience over the past six years. The world is now in the midst of another bubble — this one in commodities. It, too, will burst. The only question is when.

Conclusions

In the midst of a slightly subpar upturn in global growth, a low-inflation world is experiencing the sharpest run-up in commodity prices in modern history. (1) World GDP growth is likely to average 4.2% over the 2002-06 period — fractionally below the average 4.4% pace of the four earlier global expansions. (2) Over the past four years, the Journal of Commerce gauge of industrial commodities has increased by 53% — a sharper rise than that which occurred in any of the previous four global expansions. (3) In real terms, the JOC is up 42% over the past four years — nearly double the 23% average gains that occurred in the two commodity booms of the 1970s. (4) All bubbles are based on plausible stories of a “new era.” China is widely thought to be the key driver that keeps pushing lofty commodity prices even higher.

Market implications

The super-cycle theory of ever-rising commodity prices is based on the false premise that China stays the same course it has been on for the past 27 years. China is unlikely to do that; a rebalancing toward slower growth will reduce its impact on global commodity prices and demand.

Risks

Contagion is rapidly spreading into the far corners of commodity markets — including precious metals. Moreover, signs of psychological excess are building — in an era of globalization, tales of the “new era” are as convincing as ever. Price increases are begetting more price increases — indicative of a speculative blow-out that can only end badly.

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