Long-Only Commodity Products Pose Danger To Investors In Face Of Massive Inflows

A lot of attention has been given to the Federal Reserve’s role in rising commodity prices around the world — a phenomenon, it is said, that follows as a direct result of the Fed’s controversial quantitative easing program.

As the Fed pumps money into the U.S. economy by purchasing hundreds of billions of dollars worth of Treasury bonds, it stokes fears of inflation and causes investors (read: governments, banks, and nearly everyone else) to purchase commodities in anticipation of rising input costs as a result of the price appreciation that ensues. A self-fulfilling prophecy, to be sure.

The Fed, however, denies this apparent cause and effect in world commodity markets, seemingly ignorant of the events unfolding in the Middle East that currently dominate television screens around the world. Fed chairman Ben Bernanke even went so far yesterday, in an appearance before the National Press Club, to assert that “it’s entirely unfair to attribute excess demand pressures in emerging markets to US monetary policy, because emerging markets have all the tools they need to address excess demand in those countries.” And if by emerging markets, Mr. Bernanke refers to Algeria, Tunisia, Egypt, Yemen, Lebanon, and Jordan, it would seem that his comments make for a certain kind of curious analysis.

As Dan Dicker, senior contributor to TheStreet.com and 25-year commodity trading veteran points out, “In essence, what’s going on in Egypt looks political on the cameras, but a large piece of the wrath that’s pouring out from the Arab street is pouring out because of the increase in the price of bread. You wouldn’t see this kind of violence, this kind of rage — in spite of the fact that it’s obviously a very repressive regime in Egypt — if we hadn’t had these kinds of enormous price increases over the last year.” But where does all this extra money printed by the Fed go? Dicker points to the mechanisms that allow the prices of food and other commodities to appreciate so rapidly as cause for concern.

These investment vehicles , Dicker says, have created “an enormous increase in access to commodities that just didn’t exist even five years ago.” Here’s the punch line: nearly all of these index funds, ETFs, ETNs, and managed futures accounts in the commodity space — and especially the food space — that have popped up over the last few years are long-only vehicles. In other words, investors have been enabled to cash in only on rising prices, causing a severe market imbalance. “You have a whole bunch of financial players, none of whom have any desire to be short,” says Dicker.

How do we avoid a bubble in food prices, then? “I don’t think you can,” says Dicker, who asserts that the real issue is “whether [these products] create a mass ingress or egress of capital, which is the definition of bubbling.” As billions of speculative investment dollars pile into these long-only commodity vehicles and governments continue to stockpile food and other commodities, unrest in the poorest countries will continue to percolate around the world, as people will no longer be able to afford to put food on the table. Corporations will see a spike in input costs, which will be passed along to the consumer.

Steer clear of these commodities products. When the disconnect between prices and fundamentals emerges so clearly that it’s plain for everyone to see, the rising volatility and excess valuation that accompanies these price spikes will not lead investors to a happy ending (read: crash). The Federal Reserve will not continue down their current path of loose monetary policy forever, and eventually fears of inflation will subside. We saw it in oil in the summer of 2008, and the proliferation of new products in the food and other commodities spaces means we’re likely to see it again, but on a larger scale.

Listen to my complete conversation with Dan: ATTENTION: TheStreet.com’s Daniel Dicker on Commodity Inflation, Middle East Unrest

— Matt Boesler

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