When a lot of money tries to buy a liimted number of assets, prices go up.

What happens to those prices when the money supply dries up? Well we may be about to find out.

Investors are always moving money around looking for the next big thing, the next great return. This behavior feeds investment cycles and the vast quantities of money in the past 10 years increases the risks (and returns) based on price inflation - price increases based on increased investment money not based on fundamentals.

We have seen price inflation in housing. The concern now is that we will see it next in commodities, especially from hedge funds. Will there be a gradual flattening or a rush for the exits? At least one industry analyst has predicted gasoline prices will crash back below $2/gallon...

The first canary of commodities is Amaranth, which has reportedly lost 50% of its assets and more money than LTCM did a few years back. Expect others.

Some Investors Lose Their Zest for Commodities

Natural-Gas Debacle at Amaranth May Signal Broad Price Declines; 'Most Were Just Speculators'

By GREGORY ZUCKERMAN and HENNY SENDER

September 21, 2006

On the heels of natural-gas losses at Amaranth Advisors and other hedge funds and a tumble in numerous commodities, some investors are selling such holdings in a shift that could send prices lower if it turns into a rush for the exits.

After long shying away from oil, natural gas, metals and other raw materials, investors of all stripes -- hedge funds, pension plans, endowments and individual investors -- have become enamored with commodity investing. These investors, including short-term speculators, have become key in various markets, sometimes driving prices more than industrial customers who buy the materials to make things or sell services.

How these Johnny-come-lately investors react now "will have an effect on users, commercial producers, as well as investors," says Howard Simons, a strategist at Chicago-based Bianco Research. "The flood of money that's come in is out of scale to anything in the past, and most were just speculators."

There are 68 commodity-oriented hedge funds, up from 29 just three years ago, according to Hedge Fund Research Inc. Those figures don't include the growing number of managed-futures funds and so-called multistrategy hedge funds, like Amaranth, that also deal in commodities.

As for pension funds, "until 2003, there wasn't a whole heck of a lot of interest in commodities," says Neil Rue, principal at Pension Consulting Alliance Inc. in Los Angeles. "But commodities are becoming a major asset class and investments in the area have multiplied since 2003. It wasn't 10% or 5% a year, but much more than that." Mr. Rue cautioned pension-plan clients to be wary of commodities.

Much as they did with tech-oriented investments shortly before they tanked in 2000, individual investors also have rushed into commodities, via stocks of commodity-related companies and mutual funds that specialize in such investments. There are 48 mutual funds that invest in commodities and related shares managing $56 billion, up from 34 funds with less than $10 billion three years ago, according to fund tracker Morningstar Inc. The Commodity Real Return fund of Allianz AG's Pacific Investment Management Co. has grown to more than $12.2 billion, from $8 billion about a year ago.

The 13th-largest holder of gold in the world isn't a central bank but an exchange-traded fund, a type of security that trades like a stock and tracks the price of an underlying investment class. StreetracksGold Trust, the largest gold ETF, has assets of $7.5 billion, up from $2.7 billion a year ago, mostly from new investments.

Some investors entered these markets because they saw a long-term undersupply of a range of commodities, including oil, as economic growth in China and India increased demand. But others were less interested in such fundamentals and shifted in simply because commodities prices had gone up in recent years, hoping to catch the next wave. Low interest rates made it possible for hedge funds to borrow at attractive rates and invest in almost anything.

...

Now there are signs that some of that "hot" money is exiting the market.

"Large speculators began to liquidate gold and silver," wrote Mary Ann Bartels, a Merrill Lynch analyst, in a report this week. "But there are no signs of panic that accompany a bottom."

The end of this month could be key. Many commodity-oriented hedge funds let investors withdraw money monthly or quarterly, so if losses persist, there may be big withdrawals. That could cause more carnage in the hedge-fund world.