NEW YORK, Jun 03, 2010 (Dow Jones Commodities News via Comtex) -- The traditional relationship between copper prices and inventories has been displaced by index and hedge fund investors, and an investment bubble with high-price volatility is being created, the president of Commodity Risk Management Associates said Thursday.

David Waite told the Metal Bulletin copper conference in New York that until very recently, when copper stocks fell, prices rose--and when stocks rose, prices fell. But there has been a change in the way the economic drivers influence copper prices: Stocks rose along with prices in July 2009 until March 2010, while falling stocks since then has translated into falling prices.

"Clearly there is something other than supply-demand involved," he said. According to Waite, investment in commodities by index and hedge funds, along with the sector rotation of these investors between commodities, equities and bonds, have been added to the traditional drivers such as the U.S. Dollar and stocks.

Waite, who was involved with the setting up of the Red Kite metals-focused hedge fund in 2005, said increased price volatility will be the result of the speculative interest.

"The investment bubble may have created demand destruction, increased production and an unsustainable overhang of stocks--all financed by investment activity," Waite said. "The result could be massive price volatility, and if long-term investors lose interest in commodities, 'locust years' for metals," he added.

The equivalent of about 1.2 million metric tons of copper is tied up in index fund positions, Waite said, citing data by analysts at Bloomsbury Minerals Economics. "The index funds are holding virtual stocks that are as large as the physical market," he said.

Longer term, Wate said the threat of $4-a-pound copper prices could create a gradual increase in oversupply that, if financed by investment money, will lead to an overhang that the industry can't absorb.

Index funds also have changed since Goldman Sachs pioneered its commodity indexes, Waite said.

Waite noted that from 2004 to 2008, the buy-and-roll strategy by investors in indexes generated its yield from the backwardation, which is when future prices are lower than the cash price.

But since early 2008, the volume of the roll has been "killing the backwardation, despite the market shortage."

"By 2009, the yield of index funds has been decimated by the contango--when future prices are higher than the cash price--which was an outstanding year for the market bulls," he said. "Maybe there will never be a backwardation again."

Investors are now adjusting to the world they've helped to create, Waite told delegates, and are trading down the futures curve instead of just buying the nearby and rolling it. But investors still need to eventually roll positions, with it becoming increasingly more difficult to find buyers and sell positions more profitably, he said.

The future price structure for copper is now "inherently unstable," Waite said, being subject to swings in investment mood rather than supply-demand factors.

"These conditions encourage a permanent contango and the resumption of selective forward hedging by both producers and consumers," Waite said. "Investment buying coincides with physical surpluses and higher tolerated stock levels."