Resources, Naturally

The Daily Reckoning PRESENTS: The commodity market mystique is alive and well. Stellar successes and dismal failures in these markets are the stuff of legends. From an outsider’s perspective, commodity markets can be intimidating, even scary. In this excerpt from his new book, Kevin Kerr aims to dispel some of the common myths and misconceptions about these markets…

RESOURCES, NATURALLY

Commodity markets in various forms have been around forever, or at least since the time of ancient Greece and Rome. They even survived the Dark Ages, and reemerged at local fairs in medieval times, arranged by trade associations formed by merchants, craftsmen, and promoters.

Over the next few centuries, these markets evolved into exchanges, or bourses, in England and Europe, as well as in Japan and the New World. U.S. cash commodity exchanges first appeared in New York for trading in domestic produce. Though none of these markets exist now, they were the foundation for the commodity markets as we know them today. Since 1848, when the Chicago Board of Trade was formed, commodity futures have given producers and consumers a way to even out price moves and protect against market risk, as well as giving investors a way to capitalize on market moves.

In their early days, futures markets were used primarily to make or take delivery of the actual commodity; today, fewer than 1 percent of all futures contracts actually result in delivery against the contract. So there’s really no truth to the myth that you’ll end up with 200 head of hungry cattle grazing on your front lawn, or 50,000 gallons of orange juice cooling in your fridge, or a boxcar of grain dumped in your backyard! Unless, of course, that’s what you want.

Right now, the world is experiencing a commodities supercycle – a boom in resources that’s likely to last for at least another decade. The market for raw resources is raging – because of China, because of India, because of surging oil demand and plunging energy supplies and the crushing effect of hurricanes on offshore U.S. oil. It’s time for you to get in on the profit cycle!

History is full of gear-turning, gut-churning events, each with its own importance. But each is connected to the others by an endless cycle of supply and demand. As the world scrambles for resources, the opportunities for the savvy investor to profit are endless. And because these products are finite, we can expect demand to continue to grow. At this moment, you’re looking at one of the best times in history to make money by trading resources.

Let’s face it – trading commodities is not for the meek or faint of heart. You need sound judgment, guts, and an appetite for risk, not to mention available capital. These markets move, and they move quickly. Just take a look at all the markets over the past few months – gold, oil, grains, stock indexes, tropical markets, all of them with wild swings in both directions. There are huge risks but incredible rewards for the savvy trader or investor.

Cycles in commodities can be very predictable. There are no CEOs on the inside cooking the books. There are no accounting firms puffing up profit reports. You just have the commodities on the move. Trading on those moves, you can make money no matter which way prices are headed.

I often refer to commodities trading as “the last bastion of pure capitalism on earth.” I mean, where else can you sell something you don’t own, buy it back half an hour later, and walk away with 100 percent profit? Few investment vehicles offer the excitement, flexibility, and tremendous profit opportunities of commodities.

It’s unfortunate, but profit opportunities often are greatest when things go wrong. Look at the devastation from Hurricane Katrina. When hurricane season is in full swing it can be a very long summer indeed. Often, Gulf Coast residents have barely picked up the pieces from the previous year’s debacle when it is time to batten down the hatches yet again.

In 2005, four Category 3 storms – Dennis, Katrina, Rita, and Wilma – left a trail of havoc and destruction through a large part of the United States. Hurricane Katrina’s strong winds and heavy waves devastated the Gulf Coast in late August. The storm and resulting flooding caused more than 1,300 deaths and an estimated $100 billion in damage, making it the most expensive natural disaster in U.S. history.

Nobody can predict for sure what any storm season will hold, but some experts say we are in the beginning stages of a hurricane supercycle, which usually lasts 15 to 20 years. Stockpiling positions in some of the key commodities that may be adversely affected can be a very profitable strategy. As certain industries brace for each new storm season, traders can hedge themselves by adding specific commodities to their portfolios on a limited basis, using options or even futures to some extent.

Don’t feel guilty betting on a rough hurricane season; after all, like any type of hedging, it’s insurance. When we purchase fire insurance on our houses, we don’t hope they’ll burn down, at least not usually. No, we take out insurance to protect our investment – that’s all we’re doing.

The vulnerable markets include everything from natural gas and sugar to orange juice and crude oil. Take sugar, for example. Sugar crops have sustained hard hits in Florida and elsewhere from recent years’ hurricanes. Sugar has the added benefit of being a key ingredient in the production of ethanol and is already in high demand, so there’s a double whammy here. Another market likely to be heavily impacted by a rough hurricane season is natural gas. Remember, natural gas is used for heating and cooling – again, a double-edged sword.

Another good risk/reward scenario heading into an active hurricane season would be adding some unleaded gasoline call options to your portfolio. Whoa! I know what you may be saying: “Oh, no! There he goes using all of that trader jargon – calls, puts, straddles, strangles, and so on.” No worries; in my book, and in my trading service, it’s all about speaking plain English. We will learn what calls are, and all the other trading terms, later.

All of these commodities and many more are almost certain to experience intense volatility heading into and during hurricane season. But keep in mind that volatility drives the commodity markets. The fear of what “may happen can be more of a factor than the actual storms, so it’s best not to be greedy. Use a hedge for what it’s for: protecting your overall portfolio from the losses other holdings in your portfolio and property may take as a result of the storms.

Another thing about hurricanes is that they do a lot of damage and leave a mess to clean up. In 2005, more than 113 oil platforms were destroyed and over 400 pipelines were damaged. Sometimes the best way to play resources is to buy equities related to the companies that harvest the resources as well as provide the drilling equipment and, eventually, the transportation of the finished goods. For example, while not a direct resource play, buying stocks related to transport of oil workers from oil platforms and terminals was a very good investment that year. Even heading into the 2006 hurricane season it proved fruitful. Smaller stocks in companies that transport workers to and from rigs and facilities – specifically, boat and helicopter companies – were a very good investment.

This play was good globally, too. In the Scottish newspaper The Scotsman, Frank Urquhart wrote about it just prior to the hurricane season in 2006 (“Copter crisis threatens oil industry,” 6/30/05):

“North Sea helicopter companies are struggling to meet a surge in demand for their services because of a shortage of aircraft and crews to fly them, it was revealed yesterday. The soaring price of oil has led to a sudden and major increase in helicopter operations in the offshore oil and gas industry.”

Helicopters and transport are commodities in their own right in times of need. This is only one example of the many investment opportunities available that are simply associated with the commodities themselves. Shipping, rail, storage, you name it – if it hauls, plows, hips, builds, or refines, we can relate it to commodities and it can be a profitable addition to our portfolios.

It can be as important to understand the psychology of the markets as it is the mechanics. At the start of hurricane season nobody knows for sure just how bad it will be. One thing is certain, though – a lot of attention is being paid to it. This can often have the reverse effect on a trading market should the hurricane season be relatively light. The old adage “Buy the rumor, sell the news” certainly applies here.

In other words, put your positions on early and take early profits simply on the back of the fear of what might happen, not what actually does happen. Being married to a weather position is never fruitful for a portfolio. Simply get in and get out. A smart trading strategy would be to add one or all of the vulnerable commodities; then as you enter the season, with a bit of luck, grab fairly quick profits, even before the first winds start to really hit. There are many different scenarios – at least as many as there are weather patterns – and we will address them more thoroughly later. Remember, timing is everything.

It’s always important to be four to six months ahead of the regular calendar when trading commodities. Keep in mind that we’re trading futures not “currents”; it’s vital always to be looking forward and thinking about the impact of news, weather, and geopolitical events months in advance.

Regards,

Kevin Kerr
for The Daily Reckoning
February 8, 2007

Editor’s Note: The above was taken from Kevin’s soon-to-be-released book, A Maniac Commodity Trader’s Guide to Making a Fortune. In the book, Kevin dispels the common myths and misconceptions about these markets, offering an insider’s view of what he calls “the last bastion of pure capitalism on Earth.” Whether you’re a novice or an experienced trader, Kevin’s down-to-earth, clear-cut guidance will make you more savvy, more confident, and more able to jump right in and grab those profit opportunities that are waiting for you. The book is available for pre-sale here:

A Maniac Commodity Trader’s Guide to Making a Fortune

Kevin Kerr is the editor of two highly successful and acclaimed financial advisory newsletters, Resource Trader Alert and Outstanding Investments. A veteran commodities trader, Kevin uses his irreplaceable experience to advise his readers on a variety of commodities investments on a daily basis. Widely considered one of the nation’s top commodities gurus, Kevin’s expert opinions are routinely featured in the country’s premier media outlets.

England is a winter wonderland this morning…everything covered in white. The trains are late and traffic is halted in some areas.

Yesterday, it was the financial markets that were frozen. Not much movement. But investors still aren’t coming in from the cold.

Uh oh…we get bad news from Reuters. You know that U.S. budget surplus you were counting on? You know…that $61 billion that was supposed to show up in 2012? (After a long string of deficits, of course).

Well…don’t count on it. It may vanish, say the experts, long before it was scheduled to appear – lost to over-runs…mistakes…and just plain incompetence.

The Financial Times reminds us who is handling the cash:

“The Bush administration went on a $5 [billion] spending spree in Iraq in 2004 just six weeks before returning control of the government to Iraqis, according to a Democratic lawmaker investigating the payments.

“Huge sums were doled out, sometimes in dollar bills from the back of pick-up trucks, it was alleged.”

Mr. Paul Bremer who was on watch in Iraq at the time, admitted that there may have been a few errors:

“I acknowledge that I made mistakes and that, with the benefit of hindsight, I would have made some decisions differently. But on the whole, we made great progress under some of the most difficult conditions imaginable.”

What progress he is talking about is difficult to see. Apparently, the money was so sloppily redistributed that much of it ended up in the enemy’s hands, whoever the enemy may be.

And we’re not talking peanuts. The amount at issue is $20 billion, of which $12 billion was in cash. How can you distribute $12 billion in cash? That’s 120 million hundred-dollar bills. Even if you gave out one of them every second, every eight-hour working day…it will still take more than three years to get rid of it all.

According to the report, the United States actually took 360 tons of cash into Iraq. Who would do such a stupid thing? Rep. Henry Waxman wanted to know.

We assume Waxman was merely grandstanding for the voters; he’s been in Washington long enough to know the answer.

Meanwhile, more bad news comes from the housing market. In Orange County, CA, tax officials are having a hard time collecting. Property tax payments are getting later and later, says the local paper.

And poor Motown…U.S. automakers are taking record losses. They no longer dominate; neither the world…nor even the U.S. auto market. And the city they once made famous they now make miserable.

“Near where Piquette Avenue meets John R. Street,” reports the London Telegraph, “there is still a plaque paying tribute to the former Model T factory that once pumped out more than 1,000 vehicles a day…[now] empty runs and grass growing through the cracks in the pavement add a post-Apocalyptic grimness to this once bustling area upon which the American Century was made…”

Now the city that gave the world tail fins has lost more than half its population…and the half that is left is not the best half. More than 15% of residents are unemployed…and half are functionally illiterate, according to the National Institute of Literacy.

More news:

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Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“After seeing some strength in recent days on talk that G-7 ministers will discuss the weakness in Japanese yen, cold water was thrown on that thought by a Japanese official who said yen would NOT be discussed.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

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And more thoughts…

*** Last night, we went to the Black and White Ball, sponsored by the Conservative Party. The event brought in more than 1200 revelers, all decked out in gowns and tuxedos. It was a black tie affair, but curiously, the guest of honor – Conservative candidate for Prime Minister, David Cameron – wore no tie at all.

We were seated at a French-speaking table, which put us in a critical mood. First, the crowd seemed oddly young. It was as much a fund raising event as a celebratory one and young people don’t usually have much money to give away, and even less to celebrate. But the average age here seemed under 40. In America, a similar bash would bring out a doddering class of rich Rotarians. But these people were not only young, but rather hip, eschewing the typical black tie for what looked to us like outfits left over from Sgt. Peppers Lonely Hearts Club Band. And the women! Instead, of America’s plump 50-somethings, many of these women looked like movie stars.

Then, the entertainment began with a choreographed circus act, in which pretty girls dressed in shiny body suits dangled in the air from long bolts of fabric. They arched. They bent. They turned and twisted. We were not sure what the point of it was…but after a while, it didn’t really matter.

The candidate seemed young, attractive and smart; and his speech was smooth, positioning himself and the party as modern, ‘caring conservatives.’ And here too the Atlantic seemed to widen. There were no flags flying, no humbug about making the world safe for democracy or protecting freedom, no mention of supporting the military…and only a single word about the war in Iraq.

Mr. Cameron had gone to Iraq to visit the troops. There, he stopped into a hospital where a British soldier was lying face down on his bed, having been hit in the derriere by shrapnel. Making conversation, William Haig, accompanying Cameron, offered this reflection:

“Well, soldier, what a week you’ve had. You get hit in the backside by shrapnel and then you get to meet the conservative candidate for Prime Minister.”

“Yes…” replied the young man, “the two events are about equal.”

The 100th British soldier was killed in Iraq this week and sentiment against the war, and Britain’s involvement in it, seems to be rising.

Generally, the English have a more sober view of terrorism than Americans, probably because they are closer to it. Most of the terrorists since 9/11 have held British passports. And most English people believe that terrorism is better fought with tighter border control and stricter immigration laws at home rather than wars in distant places abroad.

“Militarism is really only popular in America,” said a French friend. “At least in the developed world. Almost nobody in France, Britain, Germany or even Japan would consider a defense budget like the United States has. Filmmakers in these countries do not make movies glorifying soldiers. They only fly flags on national holidays. And no politicians win votes by supporting military adventures.”

David Cameron focused his speech on making Britain a better place to live…and achieving this by cutting taxes, reducing regulations and allowing individuals, families and private companies to mind more of their own business. This was a theme that appealed to us; for once, we saw nothing to disagree with or make fun of.

After the speech, there were a number of fundraising efforts…including a silent auction for various extraordinary prizes. In keeping with the temper of the times, among the things you could bid on was something called “Work at a Hedge Fund.” The last time we looked, someone had offered 5,000 pounds for the opportunity. No doubt, a year from now, the winner will probably be managing $10 billion and be building a house in Greenwich, CT.

Also on offer were a race horse, a ‘home makeover,’ a week’s vacation in Nepal, and various other items we never knew we needed. Elizabeth bid on some of them; fortunately, she bid too low.

Then, the entertainment started up again. And once again, the Conservatives seemed to get ‘off message’ almost immediately. A tall, blond American cross-dresser, called something like Dee Dee from Dixie, went up to the microphone and opened with the kind of foul-mouthed schtick that used to get comedians arrested. And then another circus act – this time, a beach-clad girl wowed the audience by keeping several hula-hoops going to the tune of some appalling disco music. After that, the wrap-up band came out and played the kind of music you hear at French weddings or Russian funerals – including the Gloria Gaynor staple, “I Will Survive.”

But the evening was still a great success.

“That was a lot of fun.” Elizabeth passed judgment, as we staggered out of the cab and back to our apartment. “I wouldn’t have chosen those entertainers, but the food and wine were very good and everyone was very companionable. And that man I was sitting next to was a member of parliament. I enjoyed talking to him.”

Good food. Good drink. Good company. So what if our Crash Alert flag is flying? We’re going to enjoy ourselves.