As I write this article, the price of crude oil has already exceeded $70/bbl for a time and other commodities such as coffee and sugar have also reached record prices. Media headlines are beginning once again to highlight "speculation" by hedge funds and other investment vehicles as, yet again, being the culprits for driving up commodity prices—particularly oil. Once again, I feel compelled to counter this media theme and try to focus attention on the real issue which seems to be largely and constantly ignored by both the media and politicians alike. That is that we (the human race) are in deep trouble simply because we are finally facing the end of the era of plentiful and cheap natural resources. The movement into a supply constrained environment will have significant social and political impacts.

The Truth about "Speculators"

Hedge funds and other investors smell profit in commodities because they have understood that where we left things midsummer 2008—with almost every commodity at or close to record prices—was not a temporary phenomenon. It was the rapid collapse of commodity prices that was and remains a temporary situation.

By midsummer last year, stockpiles of most metals had reached very low levels, almost every commodity was in short supply and this was due to growing demand fueled by Asian growth and indeed North American growth. As recession loomed, demand for raw materials peaked and dropped off rapidly and as those prices fell and credit became harder to obtain and significantly more costly, investment projects were curtailed or postponed. But as soon as some level of growth returns, any excess of stockpiled raw materials will be rapidly utilized and we will experience record commodity prices again almost immediately. This is something that threatens to ensure that economies will continue to struggle under the burden of higher raw materials prices. We are in the same situation but the end result has simply been postponed awhile.

Investors looking at places to place their money all too readily see this. Commodities are the place to be. It really is that simple. Indeed, commodities are no longer an isolated group of instruments where price is dictated purely on fundamentals. They are an asset class that can and are used as a hedge against other asset classes. For example, recently, oil has again been seen as a hedge against the weakening U.S. Dollar and thus, prices have moved for reasons unrelated to fundamental factors.

Indeed, many "speculators" are trading in secondary financial markets. They are taking on someone else's risk and in doing so they play a crucial function increasing liquidity and in a sense helping to temporarily insulate producers and physical players from price increases. Yes, there are those who pursue long only strategies to benefit from rising prices but as we have observed over the last couple of quarters, many of these were badly damaged by rapidly falling commodity prices. Many no longer exist. Additionally, speculators speculate on upward and downward moving prices but I have yet to see (and most likely never will) a headline saying that prices are being driven down by speculators!

And yet it also true that over the last quarter interest in investing in commodities has begun to increase again as evidenced by the launch of many new commodity focused hedge fund vehicles.

But we are actually discussing the symptoms of a problem when we look at investors and commodities. If there wasn't a fundamental reason for commodity prices to rise why would anyone want to invest or speculate at all in commodities?

The real issue is that natural resources are finite and increasingly harder and more expensive to find. A higher oil price is required to justify the expense of developing new supplies.

Commodity Relationships and Industry Convergence

Perhaps masked by the periodic focus on speculators and volatile commodity prices is the growing convergence between commodities. Increasingly, relationships between commodities which result in price swings across broad aspects of commodity markets are helping to highlight the growing convergence between industries such as agriculture, energy, mining and others. In the past, these relationships were quite weak simply because there was some elasticity in supply but as we reach a situation where natural resources are increasingly supply constrained, they are strengthening. The focus on alternative fuels has helped set up tighter price relationships between agricultural and energy commodities while demand for energy has strengthened relationships between certain metals and energy commodities.

The resulting volatilities and tightening of commodity relationships is in a sense increasing the need for commodity price risk management—not just for traditional energy traders—but for a wide variety of producers and end users of commodities. Indeed, CommodityPoint has observed an increasing number of producers and end users procuring TRM software and we believe that these two industry segments will primarily sustain demand for that software class over the next several years.

In fact, as one examines issues such as the need for renewable energy, greater energy efficiency, alternative fuels, recycling and conservation, the more it is apparent that these are no longer simply energy industry issues but social issues that will require some significant change across industries. As an example, as countries seek to invest in wind power to meet renewable energy targets, they find that it is a supply constrained market for wind turbines and that planned projects cannot be initiated due to an inability to manufacture the turbines in required timescales. It is the fact that most raw materials (and by default, finished goods) are increasingly supply constrained that is helping drive convergence and that is setting up new dependencies between commodities, making commodities increasingly volatile and attracting " speculators" to those markets.

To me, price volatility cannot be significantly dampened by reducing the ability of investors to "speculate" nor can it be addressed by greater market oversight and regulation (not that this may not be required for other reasons). It can only be addressed by recognizing and understanding the fact that for now and the future we are truly in a supply constrained world and that demands a higher level of thinking, a more strategic set of thinking and strategies at both the national and trans national levels.