Gold closed at $686.50 per ounce, silver at $13.89 per ounce, copper at $3.4935 per pound and oil at $70.19 per barrel Friday, all of them far above those commodities’ price levels of January 1. Just how high can commodity prices soar, and what effect will it have?

One way to look at the question is to examine the peak prices reached since World War II for those commodities, and how much further they have to move to reach them, after correcting for movements in the U.S. Consumer Price index since the peak occurred (the CPI is only one such price index, and tends to understate inflation, but it provides at least a moderately realistic benchmark for long term inflation in the U.S., albeit not worldwide, since currency fluctuations are not included.)

• Gold peaked in January 1980 at $850 per ounce, equivalent to $2,200 in today’s dollars
• Silver peaked in January 1980 at $50 per ounce, equivalent to $130 in today’s dollars
• Oil peaked in 1981 at $37 per barrel, equivalent to $81 per barrel today.
• Copper peaked in April 1974 at $0.90 per pound, equivalent to $3.70 today.

If you compare current prices with historic peaks, it will immediately be seen that two of these commodities are not like the other two. Whereas oil and copper are close to their all time peaks in real terms, gold and silver are still at less than a third of their real peaks, in silver’s case barely a tenth of its real peak.

Conversely if you look at the long term usage patterns of these commodities, a very different pattern emerges. Oil consumption has increased markedly in recent years, in spite of greater fuel efficiencies, while oil supplies from conventional sources may be close to a peak. Copper and silver consumption, on the other hand, have trended somewhat downwards over recent decades, as traditional uses in electrical wiring and photography respectively have been overtaken by the new technologies of fiber-optic cables and digital photography. Gold, described by John Maynard Keynes as long ago as 1923 as a “barbarous relic” and removed even nominally from world currency usage in 1971, is driven primarily by fears of inflation and speculative forces, with relatively small industrial demand. Its supply has been flat for the last 30 years, and is currently showing a tendency to decline.

Given these price and supply/demand dynamics, one’s “how far can they go” forecast, hedged about with all the appropriate qualifications about lack of study of detailed factors that might affect the result, vulnerability of any forecast to sudden unexpected events, etc. must be as follows (ranking this time from least to most bullish:)

• Copper at $3.49 per pound is close to its all time peak, and its industrial uses have tended to decline. While new sources of copper have not been readily forthcoming, that’s largely a function of the decades-long low price trend in the metal. The largest supply sources, such as Chile, are relatively stable at present. Copper’s price might breach its 1974 peak in real terms, but not by much, and it is likely to settle back thereafter.
• Oil at $70 per barrel is also close to its all time peak in real terms, but here the demand picture is much more vigorous. Further, unlike the three metals, oil once consumed is gone, there is no recycling. On the other hand, price itself is an important signal in the oil supply market, since new sources such as oil shale and tar sands, and competitors to oil such as ethanol, become highly competitive once the oil price rises above $50 per barrel in today’s dollars. It’s likely that the long term price of oil will be substantially above the historical average price of around $25 per barrel in today’s dollars, and probably above $50 per barrel, but except for a short term speculative “spike” it’s unlikely that oil can sustain itself above $100 per barrel in today’s dollars for any considerable period in the near future. However, given the current likelihood of supply disruptions, and the overall tightness of the oil market as a whole, a further price rise in the short term to the $90-100 level must be very probable.
• Silver’s industrial uses are not the primary factor driving the metal’s price, which is speculation. The 1980 peak of $50 per ounce ($130 in today’s dollars) looks especially like a speculative bubble caused by the Hunt brothers in a market much thinner than that for gold. Nevertheless, with monetary policy worldwide having been so easy for so long, further rises in silver prices may well be forthcoming, and there appears little to prevent them. An approach to the all-time high of $130 per ounce must however be highly unlikely, and the realistic peak, absent a concerted effort to corner the market such as the Hunts attempted (and which drove them into bankruptcy) must be no higher than the $30-35 range, a quarter of the peak though more than double today’s level.
• Gold is the primary instrument of speculation against a recurrence of inflation, also the prime candidate for restoration to its ancient position of monetary authority by those concerned by the excesses of fiat money creation and the bubbles it has brought. Since monetary policy in the United States is still being tightened rather more slowly than inflation is accelerating, and the tightening may be slowed still further in the next few months by the inflationist Fed Chairman Ben Bernanke, there will be plenty more opportunities for investors to speculate on a resurgence of inflation by buying gold. Even though gold’s 1980 peak is in 2006 money $2,200 per ounce, still three times gold’s current price level, there seems no reason why that peak should not be approached again, although if the gold price gets that high it probably won’t stay there for long.

The boom in commodity prices does not have a huge direct economic effect. Only the oil price is economically highly important, and optimists who claimed at $40 a barrel that oil was now a much less important part of the U.S. economy than in the 1970s are having to change their tune now oil is $70 a barrel, nearly twice as significant in terms of the pieces of green paper that people use for money. Nevertheless, the surge in commodity prices overall is an important signal; such prices are the canary in capitalism’s coal mine that warns of trouble ahead. They show that the world economy has been allowed to base itself on a huge excess of money creation, which has resulted in wasteful asset bubbles, particularly in stocks, “funny money” investment vehicles and real estate and in excessive rewards for crooks and speculators throughout the economic system.

Soaring commodity prices are telling us that Wall Street’s view that the stock market is likely to continue drifting gently upwards is nonsense. They are also telling us that the George W. Bush administration and Republican pundits are wrong in believing that failure by the electorate to appreciate the benefits brought by first quarter Gross Domestic product growth of 4.8 percent is sheer mindless ingratitude. The reality is that the current level of stock prices and the currently inflated growth in GDP are hugely artificial, and that we have to endure the rigors of at least a repeat of the recession of 1979-82 before returning to the sunlit uplands of the soundly based growth of the 1980s. The electorate is smarter than the stock market; collectively it knows this.

Bubble-based markets benefit only speculators and crooks; they bring nothing but uncertainty to the lives of long term investors and the public as a whole. The surge in commodity prices is our signal that the current rise in stock prices and continuing economic growth are wholly artificial, not based on sound values. For that artificiality, we have primarily Fed Chairmen Alan Greenspan and Ben Bernanke to blame.

-0-

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.