The Daily Reckoning – Weekend Edition
November 25-26, 2006
by Kevin Kerr
MARKET VIEWS: RESOURCE REALITIES
There are some pretty strong arguments for considering commodity futures and options for your portfolio. But can you get the same results just holding resource stocks? Not quite…
According to Gary Gorton of the University of Pennsylvania and K. Geert Rouwenhorst of Yale who researched commodity futures contracts between 1959 to March 2004, over the last 40 years, the commodity futures index more than tripled the cumulative performance of average resource stocks involved in the production of those commodities. They conclude: “An investment in commodity company stocks has not been a close substitute for an investment in commodity futures.”
That’s not to say there’s anything wrong in investing in resource stocks. Futures and options are speculative and can provide substantial yet volatile profits this combined with steady long-term growth is always the goal for any portfolio manager. And the fact is, equities are the best way to do that.
So, if you now realize that commodities are a vital portion of your portfolio, but you are still unclear of how to dip your toe in the water for the first time? During this time of year, refineries are switching over to make more and more heating oil – so crude oil is a bit oversold right now – and I ‘m a die-hard, long term bull. My play is to use February crude oil options to my advantage buying the $70 and $72 calls for a fairly low amount and then betting that the crude price will rally from here to at least $65-$68 just on the back of demand and a tightening of supply by OPEC, among other things
This is just one way to play it…there are countless others, including natural gas, which is also oversold at this point, in my opinion. I suggest picking one of the products – or the crude itself – and then deciding which vehicle to use, whether it’s futures, options, spreads, etc. Pick options and futures with enough time value to develop at least 4-6 months, so your trade has time to develop.
In very little time, by using futures and options instead of just equities, you will be far closer to the underlying actual commodity than you could ever get using resource stocks.
As commodities legend Jim Rogers points out all the time “…gold can never go to zero, oil can never go to zero, but Enron can and did go to zero.”
for The Daily Reckoning
P.S. The resource markets and commodities futures are a vital part to any portfolio, as well as part of any good overall profit-making strategy. The profit party is just getting started, and we hope you join us at Resource Trader Alert at this time. In fact, if you join before midnight on Monday, November 27, you can avoid at $500 increase in the subscription price of Resource Trader Alert.
— The Daily Reckoning Book of the Week —
Hot Commodities: How Anyone Can Invest in the World’s Best Market
by Jim Rogers
Commodity investing has gotten a bad rap. Everyone seems to have heard of someone who “lost his shirt” trading commodity futures. What are commodities? Commodities are “things,” the essential raw materials that go into making everything from bread to automobiles. This includes foodstuffs such as sugar, wheat, soybeans, and coffee; the fossil fuels crude oil and natural gas; and industrial materials such as lumber, copper, lead, gold, and silver. As a group, they typically do well when stocks are doing poorly, and vice versa. But unlike stocks, the price of commodities can never go to zero.
Rogers, known for his world travels, his ability to size up any market, and his contrary approach to investing, says we are in the beginning of a multiyear bull market in commodities. Although he is promoting his new commodities fund, he makes a very good case that commodities belong in any balanced portfolio, particularly now. Rogers walks us through the sometimes obscure language of commodity trading, and shows us how to get involved without “losing our shirts.”
To purchase your copy of Hot Commodities, click on the link below:
THIS WEEK in THE DAILY RECKONING: So busy stuffing yourself with turkey and hiding from your in-laws this week that you missed an issue of The Daily Reckoning? Never fear…we have all the issues catalogued for you, below…
Misleading Knowledge, Part I 11/24/06
by Bill Bonner
There’s no way of knowing what will happen in the future – in fact, our investment approach is founded on ignorance. But what if you could see what will happen, a la Back to the Future? Would it make a difference? Bill Bonner explores…
by Bill Bonner
“When people think of Thanksgiving, they think of Pilgrims and Indians, sitting down at the same table to give thanks…but in this DR Classique, first run on Thanksgiving Day, 1999, Bill Bonner gives us a lesson in the real history behind the holiday…”
Invest in Commodities – And Keep Your Shirt 11/22/06
by Jim Rogers
“Investors tend to steer clear of the commodities market, saying that it’s just “too risky.” But, as Jim Rogers points out, there has been more volatility in the NASDAQ in recent years than in any commodities index. Read on…”
Time to Go Shopping 11/21/06
by Puru Saxena
“Many investors seem to think that the bull market in natural resources has come to a halt – but Puru Saxena looks at many of the factors surrounding the commodities market and determines that this bull is still alive and kicking…”
Lessons from a Kindergartner 11/20/06
by The Mogambo Guru
“All the Mogambo really needs to know about life…inverted yield curves…and gold, he learned in kindergarten. Read on…”
FLOTSAM AND JETSAM: We don’t know much – but one thing that we know for sure is that every monetary system that came before ours’ has washed up. And every paper currency every previous experiment with paper money has ended in regret and recrimination. All bubbles end. All of them. Read on…
MISLEADING KNOWLEDGE, PART II
by Bill Bonner
So, here is a general rule for you:
If someone wants to sell you an investment, you don’t want to buy it.
Investments are different from other things you might buy. You could expect to buy a good used car, for example, simply because the previous owner needed a bigger one…or wanted a snappy convertible. So too might you get a good deal on a watermelon, if the farmer had an especially bountiful crop. A nice house might be offered to you, if the previous owners’ children had grown up and moved away; he might feel it was time to ‘downsize.’
But nobody ever voluntarily downsizes an investment portfolio. Nobody ever has too many shares of a good stock…or trades in a good investment just because he’s had a hair transplant and is looking for a little action. Barring a forced sale – serious investors hold good investments until they believe they are no longer so good. Which means that buyers must realize: whenever they buy a share, they take it off the hands of someone who probably knows it better than they do and who judges it no longer worth holding onto.
And there’s another reason to look askance at what people sell you: selling costs money. Every investment that is packaged and sold requires lawyers, accountants, secretaries – not to mention advertising costs and sales commissions. Just look in any financial magazine or newspaper. What do you see advertised? Mutual funds. Insurance programs. Managed accounts. Private banking. All the things that have such wide margins that they can afford to advertise. You will find ads for funds…funds of funds…and maybe even funds of funds of funds. Because each layer carries an extra little bit of grease. The investor who buys a fund of funds of funds is practically walking down a dark street in a bad neighborhood with a sign on his back: I’m Carrying $500 in Cash!
‘But the professional will get a better rate of return,’ you might protest. ‘So it’s worth paying a little bit in commissions.’
Is that so? It is probably so that a little grease will ensure that a professional will not do anything patently absurd and foolish. He has no incentive to do so. And he’s usually learned enough about investing to avoid the obvious mistakes. In this sense, the rank amateur – if he is too lazy to read a book or think about it for a few hours – is better off paying the commission. But between the serious professional and the serious amateur, the returns will be about the same. Both have available to them the same information and the same theories.
The best investments are those no one wants to sell. They are the investments that pay no commissions or fees…that have no managers…that give no press conferences…that issue no quarterly reports…and that you have to work hard to find. These are the kind of investments private investors look for…and often wait years to buy at a good price.
Who do we all know – at least by reputation – who invests this way? Guess who? Warren Buffett, the most successful investor of all time. Buffett famously disdains the gaudy baubbles of the modern investment world. He uses no computers to do his research, preferring a yellow note pad and a Number 2 lead pencil. He waits on no brokers to provide hot tips. He is his own fund manager, a service for which he charges no fee. And he searches out companies – often over the course of many years – as a private buyer would, focusing on the earnings yield the company will bring, not on a speculative capital gain.
That is to say, in investing as in everything else, you don’t get something for nothing. The investors who succeed are those who work hard at it and avoid the public spectacle of the markets. In fact, only lazy investors are ever ‘in the market.’ Instead, the more serious they are, the more they are out of the market and into specific companies that they know inside out.
For in investments, as elsewhere, it is the ‘insiders’ who generally do better than the outsiders. This should come as a surprise to no one. The insider is the person who has eliminated the most unknowns – by actually knowing what is going on in the business. In this sense, he is the most private of investors…in Nietzschean terms, his knowledge is far more private erfahrung…actual experience…than it is public wissen…what everybody thinks he knows.
The ordinary investor cannot be an insider in the stocks he buys. But he can come very close. He can work hard to learn the industry…study the business…and get to know, in detail, both the numbers and the management. If he does his work well, he will choose an industry he likes…close to home…and stick to it for a number of years and gradually come to know the business better than the real ‘insiders.’ That’s what Buffett tries to do.
What you’re doing, of course, is lessening the likelihood that your own ignorance of the future will hurt your investment performance. The more you study, the more you know, the more familiar you are with the business – the fewer unknowns there are.
Of course, you can never entirely eliminate the unknown unknowns. That is why you must also have rules, principles and theories…they allow you to make decisions even when you don’t know the facts.
Our most deeply held theory here at The Daily Reckoning is that everything that lives also dies. It is just an observation, but it seems to apply to everything – trees, governments, financial systems, bubbles, empires, and people themselves. There is a life cycle to all things – institutions, insects, and insurrections. They begin small…they grow…they mature…they get taken over by parasites…and they die. Tout casse…et tout passe, as the French say. Everything breaks up…and everything goes away.
In the stock market there is a life cycle of from 30-40 years from one peak to the next. In the last century, the big peak in ’29 was followed by another peak in ’66 to ’68, almost 40 years later. The most recent peak is still in question.
We believe it came in January 2000. The Dow is now higher than it was then, but only in nominal terms. Adjusted for inflation, the Dow is actually about 20% lower. Adjusted to euros, the Dow is still a bit lower. But it is in terms of gold that the Dow has really been hacked down. Since 2000, it has been cut in half. In that year, it took more than 40 ounces of gold to buy the Dow stocks. Now, it takes only 20 ounces. And if we’re right about these cyclical patterns, the next major bull market in stocks may not come until the year 2040.
One little insight into how these cycles work: In the 1970s you could buy a seat on the New York Stock Exchange for about the same price as you could buy a New York taxi medallion. You needed a seat on the NYSE if you wanted to sell shares. You needed a taxi medallion if you wanted to operate a cab. Investor sentiment was so negative on equities at the time, they seemed to think you’d make as much from driving a cab as selling stocks.
But in the bullish trend that began in 1982, shares…and seats on the NYSE…sprouted wings. Now, they’re flying. You can buy a taxi medallion for about $400,000 today. But if you want a seat on the stock exchange it will cost you 12 times as much — $5 million.
We have no way of knowing, but if the patterns of the past repeat themselves, seats on the NYSE – and shares generally — are now a bad bet. You want to buy investments after they come back down to earth. And if the bear market trend really did begin in January 2000, it will probably take another 10 or 15 years to run for shares to hit the ground!
The bond market, too, may have peaked out in June of 2003…we’re still waiting to find out for sure.
And housing…the mother of all markets…now seems to have topped out. We don’t know any more than you, mind you, just what we read in the paper.
“Record inventories…” says one headline. “Sales falling in 39 states,” says last week’s AP report. “Sellers offering free cars, other incentives,” say the local news stories.
These cycles of up and down…bull and bear…are well known. What you can never know for sure is where you are in the cycle. “Markets always do what they’re supposed to do,” say the oldtimers, “but never when they’re supposed to do it.
While the Dow, U.S. bonds, and U.S. housing are probably going down, some things are probably going up. Japan has been in a slump for 16 years; it now looks like a good bet to change direction.
And gold suffered a bear market that lasted for the last two decades of the 20th century. Since George W. Bush entered the Oval Office, gold has more than doubled. It seems to be in a long-term bull market.
But there’s nothing like a 20-year bear market in his favorite metal to give a man a sense of modesty. As your author’s gold coins fell in value; his stock of modesty increased. Now, at least, he knows what he doesn’t know.
That still leaves the things about which he knows nothing at all.
Here we are in terra incognita. Since 1971, for example, the world financial system has looked to dollars to store and measure its wealth. But to what does the dollar look? Nothing at all. It merely floats on its full faith in empty promises and the credit of the biggest debtor in the world – the U.S.A. We’ve never seen anything like it. People work all their lives to lay in a store of a pure-paper money that lost half its value in the last 20 years…and could lose the other half any time. Foreign governments, pension plans, insurance companies, hedge funds too stake their financial futures on this same paper money, whose value is uncertain and whose future is unknown.
Never before have so many people had so much wealth tied up in so many dubious propositions. During the 20 years from 1980 to 2000, the capital value of America’s stocks rose more than 1000%…and the value of America’s residential housing approximately doubled. Meanwhile, so has the American government’s ‘financing gap’ gotten so large it will likely never be bridged. Between the financial obligations of the U.S. federal government and its anticipated revenues is a canyon of $65 trillion, in present U.S. dollars. No nation ever faced such a huge economic challenge.
Nor have the western economies – including Japan – ever been threatened by the competition they’re now getting from 3 billion Asians. Nor has any country ever run a trade deficit on the scale of the current U.S. shortfall of $800 billion. Nor has any country had anything like the dollar reserves now in the hands of the Chinese – more than $1 trillion of them.
Also unprecedented is the derivatives market. As recently as 10 years ago it barely existed. Now, the latest news tells us it has swollen to more than $300 trillion. What kind of shock would it take to bring it down? Even if it only shivers and shakes, what will happen to the financial system when it does?
Against all this kudzu of dollar-based wealth, debt and delusions is a solid, slow-growing oak of gold – man’s traditional way of keeping score in financial affairs – getting larger at the almost invisible rate of 1.7% per year.
How will it all turn out? We don’t know. All we do know is that every previous monetary system has washed up. And every paper currency every previous experiment with paper money has ended in regret and recrimination. All bubbles end. All of them. And when a bubble in paper money comes to end, typically people abandon the paper and rush back to gold.
Sooner or later a day of reckoning must come for the dollar, America’s trade deficit, and the world’s faith-based monetary system. We don’t know how. We don’t know when. But it is a pretty good bet that it will happen.
Of course, if you knew how it would turn out…if you could look into the future…you could take just the right action at just the right moment to take advantage of it. But we are profoundly ignorant. All we know is that, however it ends, it would probably be a good idea to have a few gold coins in your pocket when it does.
The Daily Reckoning
Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).
In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt – now available in paperback – just click on the link below: