Why commodities aren't in a bubble

published 27 June 2006

The consensus is that the commodities market is a bubble and that it has started to collapse.

This is how we see it.

Commodities bubble: is paper money better than gold?

Gold bullion has, following the recent sell-off, held above $680/oz. Gold's initial $55 fall started on Thursday 12th May at a high of $730/oz and ended the Monday following at a low of $675/oz. Tuesday, Wednesday and Thursday the price held steady above $680/oz. There are strong hands at that price, otherwise prices would have escalated down further.

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Of course, the market can make us all look foolish and it is quite possible that further price erosion could occur.

But has the world changed and do we now favour fiat money over real money? We don't think so!

Is it reasonable to expect the bull market in gold to have ended at $730/oz? We don't think so!

The gold price is set to go much higher unless the world economic conditions have suddenly changed beyond belief.

Morgan Stanley has produced some fascinating research concerning the world's gold reserves, currently at the lowest level in history. On a percentage basis of total foreign reserves, they are as follows:

US 58.3%

Germany 42.0%

Netherlands 87.0%

Spain 15.0%

Austria 22.0%

Finland 77.0%

South Africa 24.0%

Belgium 20.0%

Italy 49.0%

Switzerland 38.0%

Great Britain 7.8% (thank you Gordon Brown for selling nearly all of our gold at less than $250/oz!)

Japan 1.8%

China 2.1%

Taiwan 3%

Singapore 1.7%

Indonesia 3.6%

Peru 3.9%

Russia 9%

Saudi Arabia 7.3%.

It is quite simple to deduce from this data that those nations with huge dollar reserves hold the least gold. It seems to us nigh-on certain that some of those Central Banks will prefer more gold and less dollars wouldnt you?

Commodities bubble: can oil production keep up with demand?

Meanwhile, the oil price has pulled back a little to just below $70/barrel but it is still a bull market. The hurricane season and the American driving season get nearer every day whilst the American-unfriendly oil producers of the world pose a genuine risk to supply stability. We see investment in this sector as being one of the keys to successful future performance, although there will be some volatility along the way.

Our concern is that the global economy could suffer deterioration and that could cause a price set-back. The fundamentals otherwise seem well set.

Demand from emerging Chindia is bound to increase whilst new oil discoveries of consequence are a thing of the past. Analysts calculate that oil company share prices are discounting a medium term oil price of $40-$45/barrel.

Put that alongside Professor Kenneth Deffeyes' view. In 2001 he wrote "Hubbert's Peak: The impending world oil shortage". He reckons that by 2010 oil production will be 10% below today's level and by 2035 50% below today's level. Hardly the sort of conditions to drive the price of oil lower!

Although there has been speculation in these markets, pension funds now see the commodity market as a sector they must hold. They are long-term holders of the highest quality. There are lots of strong hands to buy these assets on pull-backs from the weak hands who panic out of them when the price seems high.

By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.