“Over the last year gold and commodities have been very profitable, but have also been a good demonstration of how crowds behave,” said O’Sullivan, adding that they are becoming increasingly dangerous.

It has been hard to ignore the meteoric rise of commodities as an asset class, especially since 2009. At the start of the year they were in the doldrums, but have since made a stunning recovery, with the price of oil trebling, and both hard and soft commodities gaining. Gold, meanwhile, rose some 73 per cent from the start of 2009 to its highest close price in May 2011.

However, following a strong bull market, commodity prices retreated earlier this month, catching some investors off guard with big losses. At its low of $105.15 a barrel on 6 May, benchmark Brent crude oil had dropped more than $16 in two days.

The well-documented forces behind the recent commodities bull market include political factors such as regime change, demographics, and inflation flaring up in parts of the globe, aided by the monetary policy actions of western governments. “Specifically, you have an unusual situation where the Fed is lagging the European Central Bank on rate rises, and these kinds of historical anomalies create uncertainty,” said O’Sullivan.

In conjunction with this macroeconomic environment, the markets for commodities have also opened up in a big way over the past couple of years; assets that were previously fairly obscure have become almost mainstream. And as demonstrated disastrously with collateralised debt obligations and the housing market, developments in financial products can have a big impact on the behaviour of asset prices. “Over the last five years, commodities have moved from the fringe of the investment world to being one of the most talked about asset types,” said  Oliver Gregson, head of investment advisory at Barclays Wealth.

In fact, the market for commodities more than doubled over the period 2008-2010, boosted by inflows of some $60 billion in 2010 and a record of $72 billion in 2009 .

Going hand in hand with this trend has been a proliferation of products, and Gregson sounded cautionary notes at the briefing on the necessity to conduct due diligence on ETFs claiming to give investors exposure to commodities.

Diversification

One of the most popular arguments for investing in commodities is for diversification, due to the lack of common price drivers with equities and bonds.

“When you add commodities to a portfolio, since 1990, and using the Dow Jones UBS Commodity Index, they do meet the requirements of a diversifier,” said Gregson.

Furthermore, the extent to which they display the desired characteristics depends on the original risk level of the portfolio, added Gregson, with the effect they have on the Sharpe ratio being much greater for low-risk portfolios.

The recent crisis prompted many to question the validity of Modern Portfolio Theory, as all assets correlated to one. But Gregson highlighted that in the tech bubble and many other instances, commodities “did what you wanted them to do”. Also, it depends on the time frame and which commodity you are referring to, as gold was one of the few assets to go up in 2008, said Marcus Grubb, managing director of investment at the World Gold Council.

Henry Lancaster, senior investment analyst at Coutts & Co, gave an insightful breakdown of the behaviour of gold following the financial crisis: in October 2008, gold fell by 20 per cent following the collapse of Lehman Brothers. Subsequently though, it rallied, and in 2009 trended strongly upwards. In the early post-crisis environment, when bank stocks were falling and safe haven assets were rising, gold performed well. Then, after the bailout plan, when the mood changed and bank stocks started rising while the dollar fell, gold continued to rally.

“This was because the fundamental dangers to the economy were still present; the bailout had only shifted those dangers from the banks’ balance sheets to government finances,” said Lancaster.

However, before indulging in a Panglossian view of gold, Lancaster struck the following cautionary note: “Good diversification isn’t very useful if you’re buying a massively overvalued asset.”

In 1980, gold stood at $835 per ounce, which in real terms is a value today of $2,400 per ounce. It has hasn’t yet returned to this peak.

The outlook

With volatile assets such as commodities, it is almost impossible to predict exactly when or by how much a trend will change.

“The real elephant in the room is what will happen to commodities once we find ourselves in an environment of global, co-ordinated fiscal and monetary tightening. In other words, when the Fed and the BoE join their Asian and European colleagues,” said Gregson.

However, this opinion was not echoed by all. It puts the behaviour of traders using commodities – and particularly gold – as a hedge against the debasing of currencies by governments at the centre of their recent performance.

“This argument assumes that governments will be able to implement a credible monetary policy,” said Grubb, pointing out that after 2008 we avoided a depression, not a recession, and Western governments hold too much debt to run positive real interest rates. “There’s only one way out of nominal debt, and that’s inflating.”

Grubb subscribes to the Paulson view that economies will competitively debase their currencies – in what is known as “beggar thy neighbour” policy. “That’s the world we’re in today,” said Grubb.

Furthermore, Grubb added that many investors are currently drawn to gold because they perceive substantial further demand growth from the commodities super-cycle, which still has a long way to develop.

Weighing in on this view with some hard-hitting figures was James Follows, a senior investment strategist at Vestra Wealth. He highlighted some points on China, tying in with the super-cycle argument.

Follows said that while it was de rigueur to worry about the short-run slowdown in China, the long-run dynamics remained intact, in terms of the resources that will be needed to fund that country’s development.

The current urban population of China – which has an overall population of around 1.3 billion – is some 540 million. A McKinsey report last year predicted this would rise by an alarming 350 million over the next 12 to 13 years. “Although this figure sounds implausibly large, it ties in with the urbanisation trends seen in countries such as Russia and Brazil since World War Two,” said Follows.

“This urbanisation is massive; it’s more than the population of the US,” he added. “The space requirements alone would require the building of ten more New Yorks.”

More than the case for gold, Follows highlighted the strain this would put on supplies of metals such as copper, iron ore and steel.

These figures appear to make it unarguable that, over the long term, there will be huge pressure on worldwide supplies of commodities. This doesn’t mean, however, that investors won’t be in for a white knuckle ride in the meantime.