Remember, just few months back everyone was speculating over commodities - Analysts at Goldman-Sachs forecasted price of oil barrel could reach $ 200, even oil baron T. Boone Pickens forecasted $ 150 (Pickens also spent millions of dollar to promote his oil independence plan)
And today oil is below $ 75, and it’s not only oil. Copper dipped to $ 2.15, wheat neared $ 550.
Does it help the consumers? Well, at least for short term. Especially decline in energy prices brings tax cut effect estimated up to $ 100 billion. But as prices fall, conservation efforts also come to halt and so does alternative energy development projects. It is interesting to see how alternative energy index fund collapsed with crude price decline.
Bizarre Mechanism : Central banks all over the world are pouring liquidity in the market. That should increase the inflation. Then how the prices are coming down?
The latest commodity price decline is another classical example of free market mechanism. For example as oil prices peaked demand in developing markets reduced since governments can no longer afford subsidies. Even in United States demand reduced. On the other hand, supply increased to OPEC increased production. Decreased demand and increased supply brought prices down.
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Speculators, who are partially responsible for the commodity bubble, believed that there will be net demand for commodities. This assumption is based on the current demand and supply numbers as well as projection that future events would disturb normal event. Events such as, for example, increase in demand from China and India.
Now lets see what happened in case of oil -
1. Oil started rising on the 'speculation' that there would be increased demand for oil from developing countries
2. Increase in demand from developed countires remains normal.
3. On the supply side OPEC would not increase output
4. There will be disruption in oil supply due hurrnicanes and other world events.
As prices increased, consumers started conserving and governments who are making oil cheap by oil subsidies can no longer afford to do so. Also OPEC increases output so as to take advantage of oil prices. Further financial crisis also means that future demand will decline.
All these events lead to bursting of 'bubble'. However bubble was created by the rational demand and supply equation. This is true about all other commodities.
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