by Alexander Green, Chief Investment Strategist, The Oxford Club
Friday, January 18, 2013: Issue #1951
At gonefishinportfolio.com, I recently updated The Oxford Club’s conservative asset-allocation strategy using Vanguard mutual funds and ETFs.
It’s been a great decade, as this investment approach has not only beaten the S&P 500, but the vast majority of professional money managers, including Warren Buffett. And not by a little.
However, some observers have noted that our performance would have been even better if we had included commodities in the mix. Hindsight is always 20/20, of course. But there are good reasons to believe that while commodities have had a terrific run over the past decade, they are likely to cool off in the years ahead.
This runs counter to much of today’s conventional wisdom. Investors in raw materials have felt like Albert Einstein over the past decade. Many money managers and investment advisors are now recommending commodity-related investments for their clients.
Yet this would be a mistake for most long-term investors. It’s a well-known fact that more than 90% of traders who speculate in commodity futures and options lose money. (You can take my word for it or hire a commodities broker and learn the hard way.) But even without the decay of a time premium, commodities are usually a lousy bet over the long run.
The bullish case for investing in commodities is not just simple. It’s simplistic. It goes something like this. Natural resources are limited. Human needs and wants are limitless – and the world population is growing by tens of millions every year. Ergo, invest in raw materials.
Let’s Make a Wager
In 1980, economist Julian Simon and educator Paul Ehrlich made a famous scientific wager. Ehrlich had argued in his bestseller The Population Bomb that mankind was facing a demographic catastrophe as population growth was set to quickly outstrip our limited ability to increase food supplies and other vital resources. The free market-oriented Simon countered that technology and human ingenuity would bring commodity prices down. He bet Ehrlich that 10 years later any five commodities he cared to pick would be lower. Ehrlich chose the ones he believed would undergo the biggest price increases: chromium, copper, nickel, tin and tungsten.
Ten years later, the world’s population was 800 million greater. Yet all five commodity prices were lower. (Tin was worth less than half as much.) Ehrlich shook his head… and mailed Simon a check to settle the wager.
Don’t get me wrong. Commodity-related stocks can make excellent trading vehicles. And raw materials companies who grow their earnings through good times and bad – by making acquisitions, increasing productivity, cutting costs or improving efficiencies – can also be good long-term investments. But commodities themselves – despite the red-hot performance of the last decade – are historical long-term losers.
There are a number of reasons for this. The first is that when a commodity becomes too expensive, we seek better or lower-priced substitutes. You won’t find many folks getting gold teeth or silver fillings any more, for instance. When the nineteenth-century market for whale oil became too expensive, petroleum products took off. And today many utilities, factories and truck manufacturers are switching from expensive oil or coal to natural gas. You can thank the previously unimagined Shale Gas Revolution.
Don’t Buy the Inflationary Argument
By the same token, gold had a terrific run from 1999 to 2011. But prices now appear to be petering out. Sure, they may rise again. But it’s worth remembering that gold briefly shot to more than $850 an ounce in January 1980 before melting down for two consecutive decades.
And those 20 years were hardly non-inflationary.
Some readers will ignore this perspective and continue to invest heavily in commodities, convinced that a rising world population or higher inflation (or both) will vindicate them in the end.
Perhaps. But time is not on their side. As author and investment historian William Bernstein recently noted: “You’re picking up nickels in front of a steamroller.”
AlexDon’t Buy This Losing Investment Advice,