Mad Money

What is behind the meltdown of commodity prices

Cramer: Get used to commodities dislocation
Cramer: Get used to commodities dislocation

As Jim Cramer watched the price of commodities like copper sink to a five-and-a-half year low on Wednesday, he can't help but wonder if there might be more to the story.

Are investors just spooked by the infamous price of crude, or could there be something lurking under the hood that explains how copper, iron and oil can roll over and get scrapped so quickly?

"The answer is that there are several bigger trends going on that are really behind these amazing declines, and they are going to keep playing out," the "Mad Money" host said.

An employee inspects coils of copper rod.
Munshi Ahmed | Bloomberg | Getty Images

The first blow to commodity pricing comes straight from the People's Republic. The price of copper shot up dramatically during the infrastructure boom of China in the early 2000's when approximately 400 million people moved from rural areas into the cities.

This huge influx of people required infrastructures to be built fast, and with boat loads of copper. China is responsible for 40 percent of the world's demand.

Here's the problem—China has slowed down, but copper production has not. The building has pretty much finished, and the copper producers are still cranking out copper like no tomorrow and there's no place to put it.

The second large theme in the plummeting price of commodities relates to hedge fund and pension fund diversification. These savvy investors created their own asset class and bought up all of the commodities. This made sense given the fact that there is high global inflation, and these assets do well in a high inflation environment.

Here is the problem—Hedge funds now realize they have made a mistake and are unwinding their bad bets. They now realize the bet they were making was on China, not the asset class, and it's backfiring on them.

The third theme behind the commodity decline is the perspective of the decline in oil. The world is viewing the decline in oil as though it is a bad thing. They waited for countries like Venezuela, Nigeria and Brazil to roll over in weakness, and that has not happened.

Meanwhile, Chinese demand has slowed and Russia is being put on the naughty list over Ukraine, and the U.S. is replacing oil imports with domestic product.

As Cramer frequently reminds investors, the price of oil is set by the "oil cartel" as he calls it. They have controlled the high price of black gold for years, and now the gang is broken up. This is the real price of oil. Not the inflated cartel price.

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Here's the problem—the decline in oil is being viewed as a sign of global weakness. It's not, and eventually it will come to light that it is actually a domestic strength.

"Don't underestimate these three changes. They are huge and they are just the beginning," Cramer said.

Meaning, this is just the beginning of a bumpy ride, one that includes lower prices in commodities before they get higher.

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