Why Boom in Commodities Has Suddenly Cooled Off

Investors tired of slumping stocks have been piling into commodities in recent months. And that's pushed up the price of oil, gold and other commodities to unheard-of heights.

But this week, the boom suddenly turned into a dizzying decline.

Gold tumbled more than $20 an ounce, oil plunged as much as 4 percent before recovering some of its losses, and wheat, corn and soybeans tumbled well below highs established over the past several weeks.

Mark Lennihan / AP

Analysts had expected a general retreat from the speculation-fueled runnup in commodities prices, but the extent caught some off guard.

"We're seeing a really dramatic pullback to the point of ridiculousness," said Kevin Kerr, commodities analyst and editor of Resource Trader Alert. "A lot of these commodities like gold reached parabolic levels very quickly. We expected some type of correction, but this is maybe overdone to the downside."

What happened? Analysts say it was a number of factors, including a stronger dollar, fears of inflation and increased profit-taking as investors took money out of commodities and moved back into stocks.

The dollar's strength -- it rose to its highest level in a week against the euro -- has discouraged buying as it now costs more to buy the greenback-denominated commodities. Also, the market reacted to the Federal Reserve's decision earlier this week to cut interest rates another three-quarters of a point, prompting worries about inflation.

How long--or how deep--the slump will last is anyone's guess. But it's a reminder that investing in commodities is a risky business.

"I knew it was coming any day now," Kerr said. "These commodities, they all look very strong and there are very bullish arguments. But when the fundamentals are completely detached from the market, it's only a matter of time."

Spot gold hit a record near $1,030 an ounce but the metal has seen a dramatic downturn since, trading around $920 an ounce by midday Thursday. Oil reached a peak of $111.80 earlier this week but was under $101. Corn futures had hit $5.79 a bushel March 11 but were at $5.08 Thursday.

Corn, the price for which has been influenced largely by demand for ethanol, has joined other agricultural commodities in regularly and rapidly hitting their trading limits in recent days, sometimes virtually as soon as trading opens.

"None of this should surprise anybody," said Mark Schultz, chief analyst at Northstar Commodity. "What is maybe a little more surprising is how quick it is and how violent. You just don't have a chance. It just opens limit and that's it."

Yet Schultz said the March 31 crop plantings report could send corn back up again, as could any indications of low corn yields due to expected bad weather.

In metals, gold has been joined by losses in silver, palladium and platinum, which soared in part because of mining problems in top-producer South Africa, which has since straightened out problems with electricity that resulted in rolling blackouts for miners. Popular exchange-traded funds for the metals, including the streetTRACKS gold ETF also have slipped precipitously. Shares of gold companies, including Barrack and Newmont , also fell sharply.

"These people didn't get into gold because they thought it would be great for 10 years," Andrew Martyn, portfolio manager at Davis-Rea in Toronto, told Reuters. "They bought gold because it was working for the last six weeks -- and now they're hitting their bid. It's very speculative."

Oil has been bitten by the same speculative bug and its price is expected to continue to ease, with a retreat down to around $90 widely expected.

"That was needed because there simply wasn't anything to support the price at those levels," Kerr said. "I don't think we're going to see a dramatic pullback. OPEC has said they will defend $80 or $85."

Margin-covering also has come into play as banks tighten lending regulations. Traders are worried that when the margin calls come they won't be able to borrow money to cover, and are thus selling their positions to raise cash.

© 2009 CNBC.com