Sudip Bandyopadhyay’s Blog

Once upon a time – six months ago, another age – anyone who could say “crack spread” without laughing was assured a lucrative job as an oil trader. Back then, when crude oil trading at $140 a barrel, the world looked Malthusian. The globe was threatened by a violent scramble for scarce resources, and peak oil theorists – or “Pot” heads – held the stage. Now the oil price has collapsed to just over $ 40 and everyone is swimming in the stuff. Curiously, for those who seek patterns in numbers, the crash comes exactly 10 years after the Asian financial crisis, when crude prices plumbed $10. Few believe crude will fall that low again – although in theory it could. Demand has contracted so rapidly that it has depressed the spot price relative to future prices, creating what oil traders call a contango.

The quickest exit from the situation would be for producers to start storing oil too – by keeping it in the ground. Pressure is rising for Opec members to do just that. Yet even when the world economy eventually recovers, extra capacity drilled during the boom will keep a lid on prices. Slowing population growth in the developing world and increased energy efficiency will curb demand, keeping prices at about $ 75 a barrel, the World Bank forecast yesterday. Rather than being different, the recent commodity boom of “permanently higher and rising prices” looks much the same as history’s many other commodity booms. All these also boosted inflation and took place during periods of strong economic growth and geopolitical uncertainty. Then they too passed and were forgotten.

The last five years’ commodities price surge has been the most marked of the past century in its magnitude, duration and breadth with the cost of energy, metals and food all swept upward. Previous booms included one or two of those segments but never all three. The reconstruction effort that followed the second world war lifted metal prices, while bad harvests pushed up the cost of agricultural products. In the 1970s, oil prices spiked and agriculture followed. But metals, after a brief jump, collapsed because of waning demand amid lower economic growth. The 1915-17 boom saw metals and agriculture rising, with oil prices playing no role. The length of the 2003-08 boom has also surprised many. The jumps of the 1950s and 1970s were shorter, although the first world war brought a similarly long period of strength. Moreover, the latest surge has involved not only conventional commodities such as oil and wheat but also exotic raw materials such as rhenium and cobalt, two metals used as superalloys in jet engines among other applications. Yet the sheer size of the rises also stands out. “The magnitude of commodity price increases during the current boom is without precedent”, says the World Bank in its latest report. It notes that prices in real-terms inflation adjusted have increased by 109 per cent in US dollars since 2003 and 130 per cent since the cyclical low of 1999. By contrast, increases in earlier booms never exceeded 60 per cent, according to the bank’s estimates. From trough to peak in the oil market, prices rose in nominal terms by 1,415 per cent between December 1998 and last July.

In general, bankers agree that although the sharp price declines of recent months could be a buying opportunity for longer-term investors who missed the boat earlier this decade, the desire to increase exposure to risky assets such as commodities is unlikely to re-emerge until the global financial crisis abates. That would mark a significant change since investors started to pour serious money into commodities about five year ago. For some it was the lure of strong returns, for others a hedge against inflation. For all, it was the appeal of diversification, amid a notion that commodities prices usually do not move in the same direction as equities or bonds. By the end of June, investors’ commodities assets under management had risen to $ 270 bn, up from about $ 10 bn in 2000. Not all the increase had come from fresh inflows; a significant portion of the rise derived from the appreciation of the assets themselves. However, assets under management fell in the thjrd quarter for the first time since 2003 to about $ 211 bn, according to Barclays Capital. Price markdowns rather than outflows accounted for the bulk of the fall, however. Whether investors start pouring money into the asset class again will depend on which view prevails; that the current drip in prices is just a blip or that the boom has ended. But for investors, executives and bankers alike the commodities boom and bust cycles teach that extrapolating today’s event into the future may prove the wrong bet. Ten years ago today, when oil prices bottomed at $ 9.64 a barrel, the common wisdom was that commodities prices were heading down. Today’s forecasts could prove equally fallible.