Commodity correction: has a bubble just popped?

When the collapse came it was pretty spectacular: the commodity play has reversed with a vengeance over the past four weeks, with the diversified DJ AIG index off 13.2% and the SGCI index off 20.2% from their year highs.

This has been seen most dramatically in the case of precious metals, with the Reuters Gold Spot index off 15.33% from its year high at the end of August and silver down 30.2% over the same period.

Suddenly those long-term super cycle grand narratives appeared to be swaying fewer minds. So is the last month a normal cyclical correction or is this the sound of history’s biggest bubble popping? 

Resistance broken

As we highlighted in an online story in mid-September, both gold and silver appeared to have moved through some significant resistance levels as investors realised that deflation was the biggest near-term risk for the Western economies, and overcame their previous distaste for the dollar.   

‘Gold has broken the 50-day moving average and may go all the way to the 200-day at 148,’ said Eric Steiman, investment consultant to US advisory Covester. ‘I see potential downside of nearly 20%.

‘Making matters worse is that the overall market is taking a major hit. Many investors that have been in the GLD trade will look to sell positions that are in or out of the money.

‘You can expect major volatility in the GLD over the coming days, but I think overall it will be much lower in time. The move up was too dramatic, and the fall will be just as bad.’

While other major commodity classes have not benefited from the previous clamour for inflation protection and have on the whole been sliding since early Q2, all have decisively taken a head down since August. Grains are off 18.41% from their year high, and industrial metals 31%.

Economist professor Randall Wray of the University of Missouri-Kansas City, one of the most consistent critics of the idea of a commodity super-cycle, is convinced that much of the pricing gains of raw materials in the past decade have been speculative excess.