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Lehman warns of commodity bubble

Record-breaking commodities prices that were drawing in hundreds of billions of dollars in new investments threaten to create an asset bubble, broker Lehman Brothers has warned.

A willingness among investors to chase returns on commodities was providing “fertile ground for a potential asset bubble,” Lehman analyst Edward Morse said in a special report.

Lehman estimates that total assets under management in commodity indices ballooned to $235 billion by mid-April from only about $70 billion at the beginning of 2006.

“Of this $165 billion increase, about $90 billion is accounted for by financial inflows to these indices, with the remaining $75 billion increase stemming from price appreciation of the original underlying investment,” Morse said.

The total amount being drawn into commodities may be even higher since the tally does not account for over-the-counter capital flows, which can sometimes be larger than flows on exchanges, according to the report.

Bubbles typically form when excessive speculation enters a market. Instead of viewing the intrinsic value of an asset, speculators in a bubble market instead focus on the resale value of the asset.

While the investments in commodities may seem small compared with the trillions of dollars sloshing around global bond and equity markets, commodity markets are comparatively illiquid, Morse noted, adding even the injection of $1 million can have a major effect in certain commodities.

Inflows have seen a major spike since December last year, with the lion's share of the contribution coming from the energy-heavy S&P GSCI index, he said.

Oil prices last week touched all-time highs approaching $128 a barrel, topping off a $50-plus run-up since September 2007, while gold raced to a record $1,030 an ounce in March. Copper at $8,880 a ton on April 17, was also a record.

Lesser-know commodities, including tin and lead, have also seen record high prices in the last year, underpinned by strong demand in China for imported raw materials. (Reuters)