The past several years have seen a growing backlash against "paper" investments as more and more investors consider hard assets to be a safe haven against the implications of central bank money printing. But as the global economy visibly slows, this question arises in many minds: Are commodities, which have been on a tear since the March 2009 bottom, finally topping out?
The question requires both a fundamental economic response as well as a technical chart analysis.
We can start by observing the common-sense connection between demand for commodities such as copper, cement, steel,etc. and economic expansion. When demand rises faster than supply, prices rise. Since supplies of commodities face all sorts of restraints in terms of extraction rates, energy costs, and declining reserves, increased demand quickly pushes prices higher.
The Big Picture
As developing world nations such as China, India, and Brazil have expanded, their consumption of basic commodities has skyrocketed, pushing prices higher and stimulating exploration for additional sources of these materials.
Now there is evidence that these developing world economies are slowing, along with the developed economies of Europe, Asia, and North America.
If demand for commodities falls significantly while supply remains ample, then prices will soften. If demand continues to exceed available supply, then prices will rise.
In other words, there are two potential drivers of commodity prices: demand and supply. If supply of a specific commodity were to plummet due to geopolitical turmoil, its price could skyrocket, even in a recessionary environment of declining demand.
Absent a sudden drop in supply, however, a global recession would crimp demand, and thus commodity prices could be expected to fall.
So the question, are commodities topping out? boils down to the question, is the global economy expanding or contracting?
The rough outlines of the bullish and bearish cases are well known to anyone who follows the economic/financial media.
The Bulls vs.