The drop in oil and metal prices this week has raised fears that a speculative bubble in commodities is bursting, but giant U.S. fund manager PIMCO says fundamentals will hold up the asset class.
In considering commodities, we need to take a more strategic view instead of trying to predict in very short term what prices might give, said Bob Greer, senior vice-president and manager for real return products at the $600-billion-fund which mainly invests in fixed income.
Many analysts saw the corrections as a normal pause needed in bull markets, particularly for energy futures and copper, which hit record high prices in the last four weeks.
But some say too many speculators were bidding up prices too high to justify demand supposedly coming from hungry economies like China and India. Some economists also fear a sudden exit of speculative investors like those that have caused real estate and dotcom stocks to crash in the past.
Greer, who oversees a $12 billion allocation for commodities at Pimco, said his model showed economics would support prices of natural resources.
To have a speculative bubble, you need one or both of two things -- one, a restricted supply of whatever it is that's going to bubble up, and two, you need to lose all concept of an objective measure of value.
The former was true in real estate. he said. Real estate is in limited supply and you can certainly bid up the price of that limited supply. In the case of dotcoms, there was a classic case of losing all concept of what a measure of value was. Neither of that holds for commodities.
U.S. crude has slid nearly 5 percent since Friday, touching five-week lows on signs high energy costs were stoking inflation and stifling consumption. Copper tumbled 4 percent early this week amid worries that any further rate hikes by the Federal Reserve could slow economic growth and undermine metals demand. Meanwhile, gold was struggling under $700 an ounce after sliding almost $52 from a 26-year high of $732 on Friday.
Greer said the real debate over commodity investments was about the passive investments in commodity futures indexes made by funds, pensions, endowments and wealthy individuals looking to hedge their investments in stocks and bonds.
Analysts say passive investment portals such as the Goldman Sachs Commodity Index, the Dow-Jones AIG Commodity Index and Reuters Jefferies CRB Index have seen total inflows of more than $100 billion in recent years, leading to an all-round surge in raw materials prices.
I do not believe that long-only index investors are driving prices, Greer said.
PIMCO is by most accounts the largest manager of commodity index mandates in the world. Yet, PIMCO does not own one barrel of crude oil, one bushel of soybeans, one ounce of gold. We do not consume any of those commodities, he said.
And as far as the objective measure of value is concerned, that occurs on the wheat fields of America, the natural gas terminals, the gasoline pumps and supermarkets where we decide how much we're going to pay for that commodity.
Greer said although there were instances when futures led cash prices of commodities, it is more likely that futures will converge to the cash, and not the other way around.
In the short term, you might have some traders in one pit looking at what's happening in another pit. But over the longer term, it will still be the fundamental economics that are unique to that market that will prevail.
So, you don't have the necessary requirements for a speculative bubble.