Commodities Bubble?

Given that I feel I have been gradually edging towards the thesis that the commodities market is on the frothy side, I think it's important to also mention the opposite point of view. This FT article mentions the possibility that current prices may reflect fundamentals:

Prices of metals such as iron ore and cobalt that are bought and sold privately between producers and customers have risen faster than others such as copper that are traded on exchanges, says Lehman Brothers.

The investment bank says this lends weight to the argument that supply and demand factors rather than just financial flows are behind the boom in prices.

Its new index of non-exchange traded metals rose by 598 per cent from January 2002 to early this year. During the same time, an index of exchange traded metals rose by 246 per cent.

There are of course a few caveats about this. First, they only refer to industrial metals here, which at the moment only constitute 7.55% of the GSCI index (11.8% of the Reuter's index). So industrial metals with markets so small that they don't even warrant exchange trading must be a truly tiny percentage of the total commodities markets. This makes it difficult to say anything important about the fundamentals of "commodities", which are actually a tremendously heterogeneous market (unless you are someone haphazardly speculating on them). Second, you have to be careful when you attempt to distinguish between bubbles and fundamentals, and the distinction is particularly difficult in the case of commodities, given that there is no future projected cash flow to discount. For example, current negative real short-term interest rates may be driving commodities prices as much as supply and demand fundamentals, and yet it's hard to know if this should be classified as an unsustainable bubble force or a fundamental force that may be expected to last for several years.

Ultimately, history justifies us in concluding that any rise in real commodity prices is a bubble, given that the long-term trend is downwards. This doesn't preclude real price increases over the next several years regardless of whether you attribute these to pure speculation or to fundamental supply and demand -- even the "fundamental" drivers of commodity prices have proven fairly short-lived. Eventually, you either dig more of the stuff up, learn to use something else, or simply pass the cost on to the consumer in the form of inflation, all of which cause real prices to return to their old level.