A colleague recently made his case for commodities to me. I understand the arguments, usually amounting to "China has a gazillion mouths to feed". However, these discussions of "aggregate demand" fail to consider an important initial source of the bubble's inertia. In essence, I disagree with their assessment of risk, but agree with some of their initial premises (i.e. increased global demand)
So, let's talk about governmental intervention.
Whenever the political mechanism is responsible for price movements, it can be equally responsible for violent volatility.
Consider the following:
What if Congress decreased the amount of subsidies for biofuel production? What if they increased the subsidies for non-biofuel use crops?
What if Congress even made a whiff of a mention that U.S. pension funds, endowments, and retirement funds can no longer invest in long only (passive) commodity funds?
What if a Federal Highway transportation (non-commercial) tax was enacted?
These are only examples off the top of my head, but they serve to illustrate that this commodity bubble has an extremely high sensitivity to putative U.S. Legislative action. This is especially the case considering commodities are priced in U.S. dollars. (comparing the U.S. dollar trade weighted index to the GSCI or DJC is an exercise I leave to the reader)
So I understand the underlying demand/supply dynamics, but those can change with the stroke of a pen...and there is far more risk embedded in such a strategy than a discussion of supply and demand dynamics.