When everyone is on the same side of the trade, the time is right for a reversal. - John Mauldin
Markets seem to work a lot like a seesaw. Fair prices lie in the middle and everyone trading stands on one side or the other, looking to buy, or looking to sell. Once one side gets to heavy, people start moving back to the other side in order to balance things out. Being that the market is inefficient it is constantly balancing from one side to the other as people try to figure out what the fairest price is.
As John Mauldin points out in his recent letter, commodities may be reaching that point where too many people are on the buy side of the balancing act. With the theory that institutional investors (companies that manage pension funds, etc) have run away from the equity (general stock) markets and sought safety in commodities (particularly futures markets where you can buy commodities for delivery in the future). This, due to seemingly lax regulatory practices compared to other markets, has allowed a great many institutional investors to take a once balanced commodities market and weigh it down on one side of the equation.
Now, it does not take a genius to realize that commodities, over time, will become more in-demand as various economies around the world grow. However, that does not guarantee that today's price, that balancing point, is a good one in comparison to prices in the near and distant future. Not having many other options for where to throw their money, institutional investors run to commodities markets for safety, weighing down the buy side of the seesaw.
The thing to note about the see-saw is that no one actually knows where the real balancing point is or whether they are on the better end of the deal. Being that people generally have a habit of suffering from group think and following the consensus of others, when there is movement on one side of the seesaw, others will see it and often rush to that side to join in the momentum.
This changing in momentum is where we see small and large bubbles develop in markets as well as their subsequent crashes as people too easily rush to overweigh one side rapidly driving prices up or down. Once there are far too many people on the same side of the equation, the seesaw is lopsided and those most in the know start run to the other side changing the momentum in the other direction all over again.
The regulation John Mauldin points out in his letter regarding traditional markets control how much people can buy of any given market, thus slowing how rapidly that seesaw rocks from one side to the other. The problem, as is quickly being recognized by regulators, is that futures markets have a loophole that allow investors to get around those controls and this loophole may soon be plugged. Once such controls are in place, the market will not rock so violently, however, if we presently are heavily weighted on the buy side of the equation few can predict how regulators will change things and whether it will cause a rapid or gradual overbalancing on the market.
The question that lingers with commodities markets is whether they are now so heavily weighted to the buy side that a reversal can take place in the opposite direction. Certainly somewhere out there is a fair price for those commodities but that price remains largely unknown. Everyone stands on one side or the other, looking to buy or looking to sell, running back and forth trying to figure out if the side they're on is the right one. The markets simply seesaw from one side to the next.
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