Commodities Comeuppance?

What the wise man does at the beginning, the fool does in the end.
-- Warren Buffett, at Berkshire Hathaway's annual meeting in Omaha, Neb., May 6, 2006.

Gold, silver and copper have made enormous moves this year, rising almost daily as booming global growth has outstripped production and left speculators sitting on huge gains. Now, after two days of heavy selling, could the smart money be leaving the building?

Gold has gained close to $200, or 40%, since the start of the year, and last week traded above $700 an ounce for the first time since 1980. Over the past five months alone, silver has rallied 65% to trade near a 25-year high of $15 an ounce, while copper more than doubled to an all-time high above $4 a pound.

For the first time, those gains seem threatened. Since peaking last week, gold is down 6.4%, silver down 10.8% and copper down 7.4%, sparking fears that a bubble is deflating. Is it? To answer that question, you must first determine the degree to which fundamentals have driven the current rally.

"There is a genuine secular fundamental story," says Anirvan Banerji, research director at the Economic Cycle Research Institute and a contributor to RealMoney, TheStreet.com's sister site. "But commodities, and industrial commodities in particular, are cyclical by nature, which literally means that a downturn is inevitable. There's no insight on whether that's tomorrow, a year from now or later."

Fundamental factors do paint a compelling picture. Chinese growth of more than 10% in the first quarter means that its giant economy will continue gobbling up a growing share of the world's natural resources. The U.S. and other industrialized countries, in the meantime, are not slowing down their own massive consumption of commodities.

On the speculative front, it's not news that hedge funds and other sophisticated investors are heavily invested in commodities. They are increasingly being joined by mutual funds and individual investors, some of whom might correspond to "the fools" that arrive at the end of a party.