Did commodity prices get ahead of fundamentals?

An example of 'wag the dog'?

The commodity price surge flew in the face of fundamentals that argued that although the recession is bottoming, large inventories -- particularly regarding oil -- indicated that the price run-up was way overdone, and that oil futures were (once again) not in-sync with supply-demand fundamentals on the ground.

Of course, institutional investors ignored the high oil inventories, and pushed oil's price higher in Q2. Then the World Bank released its revised 2009 global economic forecast, which pointed to an even worse contraction for the world's economy this year -- a huge 2.9% contraction, compared to the previously-forecast 1.7% decline -- and suddenly investors are shunning commodities, and oil in particular. Oil closed Monday down $2.62 to $66.93 per barrel.

If the commodity sell-off continues, it will re-ignite debate concerning what's at the core of today's markets, and the oil market, in particular. Some critics argue that -- given the high inventories and the severity of the global recession -- oil shouldn't be above $40 per barrel now, let alone $60. These critics argue that the concentration of institutional investors in the commodity is determining its price – in this case, creating an "artificially" high price not justified by fundamentals. Their remedy: high margin requirements for traders, among other reforms.

Supporters of the current system argue that oil's price moves are "just an example of the free market in action," another case of rational, efficient, markets.

A price surge to $147 per barrel, then a collapse to $35, then a doubling to $70 -- all in about a year. If that's an example of a rational, efficient market, "it's wearing a darned good disguise," to quote Winston Churchill.