The rebound in commodity prices is not setting any records, and in fact remains well short of normal rebound targets such as a minimum Fibonacci .382 retracement of the year-long down move. And commodity index traders are not setting any record either. They are still the largest players on long side of commodity futures markets, but they have not seen the bottom of this bear market yet. I still expect that most of these "investors" will either swear off commodities by the time they hit bottom and/or be barred by Congress from investing in commodities. If the latter, commodity prices could collapse well below fundamental value levels.

In summary, there is scant evidence that a new commodity bull market is underway. Last year’s bull market has not been fully retraced yet, as every other commodity bull market has since 1983. If the dollar breaks down to new lows on the year and gold breaks out above $1000, we will take another look. But both are low probabilities.

Of course if oil producers are buying oil futures through swap dealers it amounts to shilling–running up prices with leveraged purchases of paper oil.

read the article here…

There are definitive, obvious answers to both questions. First, the blame must be laid at the feet of speculators who have been allowed to run amuck by the Commodity Futures Trading Commission (CFTC), the very agency charged by Congress with preventing excess speculation. Why am I convinced that speculators are to blame? The answer will be obvious to fans of tv’s Dr. House. We can eliminate causes for which there is no ready cure; including supply shortages, Chinese and Indian demand, and the weak dollar. Ignoring the distraction of causes with no quick fix, we can focus on the one factor that has a prescription: excess speculation.

The source of commodity speculation is two-fold: traditional commodity pools and hedge funds who provide necessary liquidity to the futures markets, and the commodity indexers who buy and hold long futures contracts for appreciation (as they would stocks or bonds). Those who down-play speculative excesses point out that the “Commitments of Traders” report shows that the percentage of long contracts held by speculators has been declining. What they miss is that the CFTC commingles speculative long positions held by commodity index traders with those of traditional commodity hedgers—the actual end-users of commodities. This subterfuge effectively hid the accumulation of upwards of 40% of outstanding commodity contracts, making commodity index “investors,” the largest long players in US commodity markets.

How do we ascertain the commodity indexer numbers? Under pressure for more transparency, in 2007 the CFTC began publishing the positions of commodity index traders separately in the “COT-Supplemental” report. This development uncovered the fact that the four largest US investment banks dominate this business, issuing swaps to institutional funds wishing to invest in commodities, then locking in a profit by buying long futures contracts. At the behest of these swap dealers, who pleaded for continuing anonymity, the commission included only twelve agricultural markets in this weekly report. But since these swap dealers invest according to known commodity index benchmarks, we can deduce their gross positions fairly closely: currently about $230 billion in US markets alone.

The CFTC has, in direct violation of its mandate, orchestrated a free-for-all speculative environment, giving funds of all types virtual free reign to run-up prices. This has been accomplished through a covert two-front assault on federal laws: (1) Systematically raising or eliminating speculative trading limits, and (2) granting wholesale speculative exemptions to swap dealers.

The CFTC operates under the authority of the Commodity Exchange Act (CEA) of 1922. Section 6a of the CEA requires that the Commission “shall” set position limits to prevent excess speculation. In direct contravention of Congress, the CFTC has interpreted “shall” to mean “may, if I please” and instead of establishing speculative caps, has eliminated federal trading limits in all but a handful of agricultural markets.

This is why you did not hear a squeal from swap dealers and other large speculators when the CFTC announced plans to close the “London loophole,” and hold oil traders there to the same limits imposed on the New York Mercantile Exchange (NYMEX). News flash: The CFTC imposes no trading limits whatever on NYMEX oil futures trading (or gasoline, natural gas, and heating oil). The exchange itself limits trading, but only in the last three days before contract expiration, when indexers have long since rolled their massive positions forward to deferred contracts.

The lack of speculative limits would make exemptions to the limits moot, except that indexers wish to gain equivalent weightings in relatively small grain and livestock markets where limits still exist. Section 6c of the CEA states that the only exemptions permitted are for “bona fide hedging.” Here the CFTC’s own rules are in agreement with the CEA; they have simply chosen to ignore them. US Code Title 17 defines who is a bona fide hedger in such intricate detail that no one of reasonable intelligence could mistake swap dealers JP Morgan Chase, Citigroup, Bank of America, Wachovia, or HSBC North America as legitimate “bona fide hedgers” such as farmers, grain merchants, and other cash market participants.

What should Congress do? The question of whether commodity investment is good public policy should be debated in Congress, and not decided by a handful of political appointees drawn from the very industry they oversee. But please, first investigate current law enforcement before adding unneeded regulation. Congress anticipated the current mess, which might have been largely averted but for regulator subversion.

• Before rubber-stamping current CFTC requests for more funding, ask the right questions of the acting Chairman Lukken. The big one: “Under what authority are you granting swap dealers exemptions to, or just plain eliminating, mandated speculative trading limits?” Number 2 might be to provide a rational explanation of how a small group of traders could accumulate 30% to 60% of a commodity’s long contracts and—as the agency claims—not inflate prices.

• US futures markets are easily the most transparent markets in the world. But they and the public would benefit by requiring the CFTC to make permanent the 2-year pilot program under which it publishes the weekly “Commodity Index Trader” report and expanding it to include all futures markets. The CFTC should also require and publish the same trader report for foreign boards of trade and regulated swap platforms as a requisite for US distribution.

• In your deliberations, be mindful that commodity bull markets are cyclical and responsive to laws of supply and demand. High prices discourage buying and stimulate new production, eventually retracing. Though the current run-up is arguably more speculative than usual, there is no reason to believe this time is different. This bubble will likely take care of itself long before Congressional action (or a Presidential magic wand) could be effective.

• The direct and most efficient course would be to compel the CFTC to implement real speculative trading limits in accordance with current law, and to comply with their own regulations, which clearly disqualify swap dealers and other index traders for exemption from speculative trading limits. A logical first step might be to cap swap dealers positions at current levels.

• A caveat: There is no evidence that the CFTC is capable of correcting the speculative excesses that they continue to deny. Even the most deft and delicate attempt to deflate the current bubble is likely to cause reverse market distortions even more painful than the bubble itself.

ECONOMIC BEAT  
A Simple Old Reg That Needs Dusting Off
By GENE EPSTEIN
Fixing the inflation problem.

IN ITS STATEMENT ACCOMPANYING ITS DECISION last week to leave the short-term interest rate unchanged, the Federal Open Market Committee expressed concern about "the upside risks to inflation," specifically mentioning the "continued increases in the prices of energy and other commodities."

Meanwhile, the Homeland Security and Governmental Affairs Committee held Capitol Hill hearings on "Curbing Excessive Speculation in the Commodity Markets."

The connection between the two events was little noticed but is direct: Something can be done about the higher prices of food and fuel — the source of the inflation that concerns the Federal Open Market Committee. Much as I hate to agree with any politician who blames the speculator whenever goods get too dear, which usually amounts to shooting the messenger, Homeland Security Committee Chair Joe Lieberman unfortunately had a point when he accused speculators of "artificially inflating the prices of food and fuel futures."

The remedy for restoring stability, however, is far simpler than Senator Lieberman seems to realize. Instead of acting on his resolve to "introduce comprehensive bipartisan legislation to address excessive speculation," his committee should simply demand that the Commodity Futures Trading Commission enforce rules that have been on the regulatory books since 1936.

The rules the CFTC should enforce are position limits that specify the maximum number of contracts in a given market that any single speculative entity can hold. These limits, which generally amount to about 2% of all contracts outstanding, are set for a good reason: The commodity markets are too small to absorb an excess of speculative dollars. Even at current inflated prices and a near-record level of trading interest, the total contract value on all domestic commodity exchanges comes to only $960 billion. By way of comparison, even at current depressed prices, the total market capitalization of all domestically traded stocks tops $13 trillion.

But as though commodity markets were as large as stock markets, a new breed of commodity index "investor" has taken speculative buying way beyond anything domestic commodity markets have ever seen. These commodity indexers ignore individual market fundamentals, instead flooding liquidity into markets based solely on the weightings dictated by one or another commodity index benchmark. The flood has become a torrent. For example, based on commodity trader Steve Briese’s calculations, "long" bets by the indexers in wheat account for nearly 60% of the 2007 domestic wheat crop.

Some analysts still insist that, despite the huge volume of speculative bets, prices are merely reflecting supply-demand fundamentals. (For an alternative view, see "Oil Bubble" in last week’s Barron’s.) But even if the bulls are right, they should have nothing to fear. To avoid all possible dislocations, let position limits imposed on the indexers be phased in — say, over a period of six to nine months. Then, if the fundamentals really do justify these lofty price levels, the absence of this speculative liquidity will hardly make a difference.

The indexers circumvent position limits by trading through dealers that belong to the International Swaps and Derivatives Association. These "swaps dealers" serve as market-makers for the index funds, while laying off their speculative risk on the organized commodity markets. Back-of-the-envelope calculations I did with Briese show a huge retrenchment if speculative position limits currently on the books were imposed on the swaps dealers. For example, in corn and soybeans, they would have to rid themselves of at least half the value of their current long positions in these two commodities.

Swaps dealers’ positions in crude oil are not available. But based on the standard commodity indexes, it is possible to make rough estimates. Briese estimates that their long bets on the New York Mercantile crude oil contract could account for more than a third of all long contracts, or the equivalent of nearly 90 days of U.S. consumption. Apply proportionately similar position limits in force for soybeans and corn, and there, too, at least half these long bets would have to be covered.

The CFTC currently exempts swaps dealers from position limits on the basis of an argument that would bring the commissioners a flunking grade in Econ 101. Contrary to the CFTC, the swaps dealers are not "hedgers," since hedgers are clearly defined as those who take offsetting positions in the physical commodity. In their role as market-makers for the index funds, the swaps dealers are taking offsetting positions, but they are obviously not dealing in the physical commodity.

History teaches that regulatory commissions often become hostage to the very industry they’re supposed to regulate. In that regard, it’s worth noting that CFTC Commissioner Jill Sommers is a former Head of Government Affairs at the International Swaps and Derivatives Association.

Say that legislators do ride herd over the CFTC by requiring that it enforce position limits. Even if, as proposed, the rules were phased in slowly, Briese fears an anticipatory collapse in prices that could drive the swaps dealers into bankruptcy. While that would hardly be welcome, the decline in food and energy prices would provide welcome relief to consumers.

E-mail: gene.epstein@barrons.com
      URL for this article:
http://online.barrons.com/article/SB121460970889212409.html

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

Of course, the laws of unintended consequences pertain. Some commodities have daily trading limits. If a bearish shock were to hit these markets, bulls have to potential to be locked in adverse positions as prices fall day after day without any significant trades taking place. I have been there. It ain’t fun.

If the CFTC simply wants to panic the market, this is a good start. Read the advisory at: http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/cftcemergencyauthoritybackgrou.pdf

This announcement does have market-moving potential if it is perceived as restricting the buying activity of commodity index traders. I cover the CFTC’s current and historical policies regarding CITs on pages 9 through 13 of my book, The Commitments of Traders Bible. To recap, the Commission has been most accommodating to these long-only commodity “investors” represented by the largest swap dealers. They have granted wholesale exemptions from speculative trading limits imposed on traditional commodity and hedge funds. Last fall they announced their intention to drop limits altogether for long-only commodity indexers. (This idea has since been put on hold.)
 

And the CFTC has refused to go on record to explain how these exemptions meet the requirements of the Commodity Exchange Act, which requires the CFTC to establish speculative position limits, allowing exemptions only for “bona fide hedges” by firms involved in the respective commodity’s cash business (supply chain). It is pretty clear that the CFTC has exceeded it authority in concessions to swap dealers.

Here is the danger. If the CFTC were to announce new, genuine restrictions on swap dealers—who are the largest players on the long side of commodity futures—the resulting loss of buying power, or resulting selling pressure could impact commodity prices. There may be a lot of longs trying to exit the markets at once in anticipation of lower prices.

Many commodity markets employ daily price limits. In recent months, hitting a trading limit has become a common event. It may be difficult or impossible to exit a trade in a market that has moved the daily limit against your position. The potential risk on Monday is to long positions. If the market interprets the CFTC’s announcement as bearish, you may want to have your stop-loss within the daily range and in the market. This still does not guarantee a fill, which are executed on a first come-first served basis.

Daily limits are generally increased following a lock limit day. But markets can stay locked even at expanded limits. Losses can mount quickly under these conditions. So quickly that counter-party payment risk could become a concern. But isn’t this risk removed through central clearing in the futures markets? In theory, yes, but the CFTC’s exemptions have concentrated something on the order of $200 billion (contract value) with the majority held by just 4 large swap dealers. These are the same firms that have already written off 10s of billions of dollars in subprime loan losses, and have had to go looking for new capital in the Middle East and elsewhere to stay solvent. These swap dealers will need cash to meet margin calls if positions move against them. We have already witnessed an old-line investment bank go under because of a cash shortage. The futures clearing houses have not been tested under conditions where such a large player could not meet a margin call.

I really don’t like being alarmist, but I am not confident in the CFTC’s willingness or ability to resolve the problems their ill-advised (and likely illegal) actions have created.

Bunk. The CFTC’s announcement provides not one new piece of public information or data about the petroleum markets. We are simply to take their word that they are increasing surveillance.

If the CFTC truly wishes to provide greater transparency, it would include petroleum markets in the COT-Supplemental weekly report, which breaks out the positions of commodity index players. These are the largest long players in the dozen markets that the CFTC does report, suggesting that they are a dominant player in oil as well.

The curtain has already been pulled on the Commission’s using the "commercial" category to camouflage the big swap dealers holdings. Why don’t they just come clean and report the totals.

These should also include the ICE crude oil contracts. After all, ICE is an American company, which by operating in London allows large traders a certain degree of anonymity not provided here. The CFTC allows ICE trading terminals in the US. They should report the large traders. Just my opinion…

WHEAT -     CHICAGO BOARD OF TRADE                                       Code-001602  

FUTURES ONLY POSITIONS AS OF   04/15/08                         |  

--------------------------------------------------------------| NONREPORTABLE  

      NON-COMMERCIAL      |   COMMERCIAL    |      TOTAL      |   POSITIONS  

--------------------------|-----------------|-----------------|-----------------  

  LONG  | SHORT  |SPREADS |  LONG  | SHORT  |  LONG  | SHORT  |  LONG  | SHORT  

--------------------------------------------------------------------------------  

(CONTRACTS OF 5,000 BUSHELS)                         OPEN INTEREST:      379,563  

COMMITMENTS  

  92,002   66,997   53,450  203,628  209,299  349,080  329,746   30,483   49,817  

  OPTION AND FUTURES COMBINED POSITIONS AS OF   04/15/08          

|  --------------------------------------------------------------| 

NONREPORTABLE        NON-COMMERCIAL      |   COMMERCIAL    |      TOTAL      |   POSITIONS  

----------------------------|-------------------|-----------------|-----------------    

Long  | Short  |Spreads |  Long  | Short  |  Long  | Short  |  Long  | Short  

--------------------------------------------------------------------------------  

(CONTRACTS OF 5,000 BUSHELS)                         OPEN INTEREST:      535,557  

COMMITMENTS    

87,091   60,080  170,063  243,134  248,498  500,289  478,642   35,268   56,915  
 

How can this be? There can’t be a negative number of option positions open. The explanation is in the

NON-COMMERCIAL SPREADS category. Large speculators are spreading between futures and options.

If you look at Futures only, it looks like a straight long or short position, but when you include options, the spreads become apparent. I am not interested in the spread number, but I am interested in eliminating spreads from the net positions. This is accomplished by using the Futures + Options (or Index Trader) report.

Release: 5486-08
For Release: April 15, 2008

Provides Various Ways to Access the Public Forum

Washington, DC – The Commodity Futures Trading Commission today released the participant list for the upcoming roundtable discussion on the agricultural markets. The roundtable is designed to gather information about whether the futures markets are properly performing their risk management and price discovery roles. Due to significant space limitations in the Commission’s hearing room, the CFTC is offering several avenues for interested members of the public to access the roundtable.

Roundtable Participants

In addition to CFTC participants, the roundtable will include participants from the following:

United States Department of Agriculture
Farm Credit Administration
Federal Reserve Bank of Kansas City
University of Illinois, Urbana
CME Group
ICE Futures US
Minneapolis Grain Exchange
American Bankers Association
Goldman Sachs
AIG
Gresham Investment Management LLC
PIMCO
Dunavant Enterprises
American Cotton Shippers Association
National Cotton Council of America
AMCOT
National Grain and Feed Association
National Wheat Growers Association
Grain Service Corporation
National Corn Growers
National Cattlemen’s Beef Association
American Soybean Association
National Farmers Union
American Farm Bureau Federation
Commodity Markets Council
American Bakers Association
Independent Bakers Association
Michigan Agribusiness Council
USA Rice Federation/US Rice Producers Association

How to Access the Roundtable

Potential Questions for Consideration at the Roundtable

Members of the public may submit questions to be considered for use during the roundtable. All questions should be sent to agforum@cftc.gov. The deadline for question submissions is 5:00 p.m. EDT, Friday, April 18, 2008. Submitting a question guarantees it will be considered, but does not guarantee it will be asked during the roundtable.

Statements for the Record

Participants and members of the public may submit written statements for the official record. Statements should be sent to agforum@cftc.gov. All written statements must be received by 5:00 p.m. EDT, Wednesday, May 7, 2008.

CHINA, AS EVERYONE KNOWS, IS A BIG FORCE IN THE extraordinary boom in commodities. Its voracious appetite for everything from corn and wheat to copper and oil has helped push up U.S. commodities prices by some 50% over the past 12 months.

But China is by no means the whole story. Speculators — including small investors — are also playing a huge role. Thanks to the proliferation of mutual funds and exchange-traded funds tied to commodities indexes, speculative buying has gone way beyond anything the domestic commodities markets have ever seen. By one estimate, index funds right now account for 40% of all bullish bets on commodities. The speculative juices are even more plentiful — nearly 60% of bullish positions — if you count the bets placed by traditional commodity "pools."

Index funds with buy-only strategies have had outsized influences on the market.

Here’s the problem: The speculators’ bullishness may be way overdone, in the process lifting prices far above fair value. If the speculators were to follow the commercial players — the farmers, the food processors, the energy producers and others who trade daily in the physical commodities — they’d be heading for the exits. For right now, the commercial players are betting on price declines more heavily than ever before, says independent analyst Steve Briese.

For example, in the 17 commodities that make up the Continuous Commodity Index, net short positions by the commercials have been running more than 30% higher than their previous net-short record, in March 2004.

Briese, author of the recent book The Commitments of Traders Bible and editor of the Website CommitmentsOfTraders.org, was one of the first to recognize that information on the bets made by the commercials could provide rare insights into how the "smart money" views the price outlook. These days, the data suggest, the smart money clearly believes that the market’s exuberance has turned irrational.

Analyst Steve Briese sees heavy short-selling by pros.

IT’S NOT EASY TO SIZE UP THE influence of the index funds. But based on their known cash commitments in certain commodities, and the commodity indexes their prospectuses say they track, it is possible to estimate the size of their commitments in all commodities they buy. Using this method, analyst Briese (pronounced "breezy") estimates that the index funds hold about $211 billion worth of bets on the buy side in U.S. markets.

Applying a similar method, but with slightly different assumptions for indexes tracked, Bianco Research analyst Greg Blaha puts that figure at $194 billion. Either figure is enough to turn the index funds into the behemoths of the commodity pits, where total bullish positions now stand at $568 billion.

Commodities index funds, which arrived on the scene in the late 1990s, have come into their own in the past several years. The biggest index fund, Pimco Real Return¹ (ticker: PRTNX), has seen its assets swell to $14.3 billion from $8 million since its inception in January 1997.

Index funds offer investors an easy, inexpensive way to gain exposure to a segment of the commodities markets or a broad-based basket of commodities. Result: The funds have drawn many private investors who have never ventured into futures, along with pension funds and other institutional players looking to diversify. But for all the virtues that the funds hold as a way of spreading bets across commodity markets, they take only long, or bullish, positions, avoiding short-selling. In other words, they trade on the naïve and potentially fatal assumption that commodities have the same tendency as stocks to rise over the long run.

That this large, bullishly oriented group of funds is flourishing is partly a result of a regulatory anomaly. In recognition of the fact that the commodity markets are too small to absorb an excess of speculative dollars, the Commodity Futures Trading Commission, in conjunction with exchanges, imposes position limits on speculators. But the agency has effectively exempted the index funds from position limits.

The dislocations caused by allowing so much money into markets that have limited liquidity is now causing alarm in the trading pits. That, in turn, is prompting the CFTC to call for an industry gathering April 22 at its Washington headquarters "to hear firsthand from participants to ensure that the exchanges are functioning properly." On this and related issues, CFTC Acting Chairman Walter Lukken declined to comment to Barron’s.

Unless regulators clamp down, the index funds could become an even bigger force in the markets. In the midst of the recent sell-off, commodity bull Jim Rogers made that very point in an interview with Bloomberg News. Referring to the "over 70,000 mutual funds in the world" compared with the "fewer than 50" that now invest in commodities, he held out the prospect of a speculative bubble that could last for years.

In Rogers’ view, the bull market is in the "fourth inning" of a "nine-inning baseball game." To which commodity bear Steve Briese counter-quips, "Maybe, but can’t the game be called for a year or two, on account of rain?"

IN THE ORGANIZED COMMODITY MARKETS, trading is in futures and options, which are essentially two-way bets on the outlook for prices. For every buyer (a "long") of a future or options contract betting on a price rise, there is a seller (a "short"), taking the other side of the contract by betting on a price decline. Since speculators and commercials as a group can be either short or long, the charts (see the last page) track the net position — longs minus shorts — held by either group. Courtesy of Briese, the charts track net long or short positions in dollars, based on the dollar value of the commodity each futures or options contract covers.

The speculators, now so bullish, are mainly the index funds. To see how their influence on the market has become outsized, just look at how they operate. Nearly $9 out of every $10 of index-fund money is not traded directly on the commodity exchanges, but instead goes through dealers that belong to the International Swaps and Derivatives Association (ISDA). These swaps dealers lay off their speculative risk on the organized commodity markets, while effectively serving as market makers for the index funds. By using the ISDA as a conduit, the index funds get an exemption from position limits that are normally imposed on any other speculator, including the $1 in every $10 of index-fund money that does not go through the swaps dealers.

The purpose of position limits on speculators, which date back to 1936, is clearly stated in the rules: It’s to protect these relatively small markets from price distortions. An exemption is offered only to "bona fide hedgers" (not to be confused with "hedge funds"), who take offsetting positions in the physical commodity.

The basic argument put forward by the CFTC for exempting swaps dealers is that they, too, are offsetting other positions — those taken with the index funds.

Position limits on speculators, in some commodities specified by CFTC rules and in others by the exchanges, are generally quite liberal. For example, the position limit on wheat traded on the Chicago Board of Trade is set at 6,500 contracts. At an approximate value of $60,000 worth of wheat per contract, a speculator could command as much as $390 million of wheat and still not exceed the limit.

But at least one index fund that does trade the organized commodity markets directly and must therefore abide by the rules — PowerShares DB Multi-Sector Commodity Trust (DBA) — recently informed investors that it was bumping up against position limits and therefore would change its strategy.

No such information is available from individual swaps dealers. But based on CFTC data on their total position in a commodity like wheat, together with the fact that only four dealers account for 70% of all the trading from the ISDA, it is quite clear that if the exemption were ever rescinded, the dealers’ trading in these markets would no longer be viable.

Speculators also use the older commodity pools, whose position is likewise tracked on the charts. The pools, open to sophisticated investors, are flexible enough to sell short as well as buy long and are subject to position limits. But since they are generally trend-followers, they will almost always go long in bull markets. Through most of the recent period, then, the pools have been adding to the price distortions caused by the index funds. Add the pools’ bets to those of the index funds, and speculative money forms 58% of all bullish positions.

To get a further idea of the impact of these speculative bets, Barron’s asked Briese to measure them against production in the underlying markets. He calculates that in soybeans, the index funds have effectively bought 36.6% of the domestic 2007 crop, and that if you add the commodity pools, the figure climbs to 59.1%. In wheat, the figures are even higher — 62.3% for the index funds alone, and the figure jumps to a whopping 83.6% if you add the pools. Betting against them as never before are the commercials, who deal in the physical commodity.

The CFTC provides these figures on index trading for only 10 commodities. Why are such major commodities as crude oil, gold, and copper excluded? The agency’s rationale, which even certain insiders question, is that it would be hard to get reliable information on these other commodities from the swaps dealers.

WHAT MIGHT FINALLY TRIGGER THE bursting of the commodities bubble?

One possible trigger was cited in a Barron’s interview with Carl Weinberg of High Frequency Economics, published last week. Weinberg anticipated a break "some time this year" in industrial commodities, including crude oil, copper and natural gas once there is news of "even the slightest slowdown in the Chinese economy," the country whose insatiable demand, together with that of India, has been a rallying cry of the bullish speculators. When industrial commodities prove vulnerable, speculative money could start fleeing agricultural commodities, also.

Société Générale analyst Albert Edwards goes much further. Based on his view that the "Commodity bubble is nonsense on stilts," Edwards holds the "very strong conviction that before the end of this year, commodity prices…will be unraveling." He believes the triggering events will be the "unfolding U.S. consumer recession" and likelihood of "negative CPI [consumer price index] inflation rates."

A sudden turnaround in the dollar could be another trigger, notes Briese. By making dollar-denominated commodities ever cheaper in terms of other currencies, the collapsing dollar has been a legitimate bullish factor. "But the buck won’t go down forever," Briese argues. "The same cycles that coincided with the dollar’s major bottom in 1992 are due to make a low later this year. A rebounding dollar would pinch demand for dollar-denominated commodities."

Alternatively, to borrow a quip from the late humorist Art Buchwald — who once explained that his candidate lost the election owing to "not enough votes" — the bubble could burst from not enough buying. Brokerage houses have been advising their clients to allocate part of their portfolios to commodities, compared with allocations of zero several years ago. Even a shift of five percentage points would have been more than enough to account for the dollars that have fueled the "nonsense on stilts."

But what if the U.S. economy proves more resilient than currently thought, doesn’t fall into recession, and instead starts growing again? The resulting rally in the stock market could send the allocation share back to zero and the bubble could burst, not with a bang, but with a whimper.

The CFTC could also prick the bubble by enforcing its own rules. If the agency were to rescind the exemption on position limits given to the index funds (say, on a phased basis, so that the funds could make an orderly retreat), prices would probably fall back to reflect their true supply-demand fundamentals.

Briese’s analysis of commercial hedger positions leads him to believe that commodities in general were fully valued in terms of the fundamentals as of early September 2007. Based on the 24-commodity S&P Goldman Sachs Commodity Index, that would mean about a 30% collapse from present levels. But, he adds, "Given the tendency for prices to overshoot, commodity values could be cut in half before they stabilize."

Maybe it’s time to start listening to the smart money.