Commodities have endured a steep selloff over the past couple of weeks, a fact that has prompted vast hordes of market analysts to proclaim, with absolute certainty, that the "commodities bubble" has burst.

We find the whole situation to be a bit ridiculous. After all, the large majority of these very same analysts were entirely unable to identify the hugest housing bubble in the recorded history of the world, and before that, most of them were unable to identify the hugest stock bubble in the recorded history of the world. As a matter of fact, many of them have spent the past several years warning about an imminent collapse in commodity prices (which didn't happen) at the very same time that they were denying the aforementioned hugest-ever real estate bubble and assuring everyone that home prices would keep rising (which also didn't happen).

Have they now suddenly started getting it right?

No, we think not.

Bubbles occur when prices rise in large excess to their historical fundamental valuations based on almost universal expectations of further capital gains. While both these factors were present in the oft-denied real estate and stock bubbles, neither of them apply to the commodities sector. (For the purpose of this article, incidentally, we are lumping precious metals in with commodities).

Sentiment

Let's start with the second factor above: the universal expectations of further gains. Is this going on in the commodities market? Hardly. Just look at what's taking place in reaction to the recent correction. People don't point out that commodities have been falling for just two weeks after rising for 7 years. They don't mention that the decline has only taken prices back to their levels of about a month and a half ago. They don't acknowledge that the commodities market has had a history of experiencing occasional sharp selloffs during its 7-year bull market to date.

Instead, they claim that the commodities "bubble" -- that same bubble that they've been talking about for most of the commodity bull market -- is bursting, and that it turns out they were right all along.

This is not what happens at bubble peaks. At bubble peaks, everyone is on board. They are bending over backwards to explain why despite sky-high valuations, the price gains are sure to continue. Skeptics are few, far between, and dismissed as "chicken littles."

Believe us, we know, as we were among the early skeptics of the San Diego housing bubble. Think back to the peak of that bubble. Everyone was talking about their huge real estate gains. The few naysayers were dismissed as cranks who were jealous and just didn't "get it." And -- this is very important -- people didn't generally accept that there had been a bubble until long after the bubble had started to burst. San Diego home buying activity peaked in mid-2004 and prices peaked in late-2005, yet a huge number of people -- and almost all real estate analysts -- failed to acknowledge that there had been a bubble until late 2006 or 2007.

Right now, in contrast, it seems to us that the only people who are few and far between are the ones who believe that commodities aren't in a bubble. That's just not the way bubbles work.

Valuation

Let's have a look at the changes in valuation that took place during the tech stock bubble and the San Diego housing bubble. We will use the NASDAQ index price for tech stocks and the S&P/Case-Shiller San Diego home price index for housing. Both figures will be adjusted for CPI inflation, which provides a rough indicator of valuations by comparing how expensive the stocks and houses were in comparison to other things that consumers could buy.

As you can see, both markets experienced huge spikes that took their valuations to levels far in excess of what had been seen in the historical data:

Now, have a look at the CPI-adjusted CRB commodities index:

This chart looks quite different from the first two. The price rise of recent years looks a lot less like a bubble than it looks like a rise from the extremely low valuations that prevailed earlier in the decade, at a time when commodities were emerging from a brutal multi-decade bear market. Commodities may not be as cheap as they were, but they certainly aren't at bubble pricing.

Now, we are not saying that commodities won't correct further from here. They very well might. They have experienced the type of steep runup that is often followed be fairly severe corrections, even in a bull market, and they could be adversely affected by both the economic slowdown and financial market deleveraging that are currently underway.

But nothing goes up in a straight line, as they say, and it's important to understand the distinction between a temporary correction and a bursting bubble. This is no bubble.