Hotelling's Theory

Hotelling’s theory is the theory that owners of nonrenewable resources will only supply their commodity as long as it pays off more than they would get if they invested their money, particularly in U.S. Treasury securities.

Economists use Hotelling’s theory to try to predict the future price of copper, oil, coal, nickel, and other nonrenewable resources, using the current interest rates.

Basically, every nonrenewable resource owner makes a choice every year: either extract and sell the resource now and invest that money, or wait to extract and sell the resource until next year. If market interest rates were low, like 4%, and someone sitting on coal reserves thinks that the coal will appreciate 8% in the next year, it’d make more sense for them to wait until next year.

The Fed did a study that proved Hotelling’s theory not so sound, but maybe that’s because extraction costs were not included in the calculation. Hotelling’s theory is also reliant on others' expectations of commodity appreciation, which could be misguided or...just plain wrong. After all, nobody’s that great at predicting markets.