Don’t Buy This Losing Investment Advice
by Alexander Green, Investment U Chief Investment Strategist
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.
If only…
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.”
Good Investing,
Alex
Don’t Buy This Losing Investment Advice,Any investment contains risk. Please see our disclaimer.
7 Responses to “Don’t Buy This Losing Investment Advice”
Comments
By submitting your comment you agree to adhere to our Comment Policy and Privacy Policy.
Check out our selection of daily investment research:
 |
 |
Your argument against commodities has some valid points. However, by my back of the envelope calculation, the Permanent Portfolio (25% in stocks,bonds,cash,and gold) has achieved an almost equal gain with a considerably lower standard deviation. This also has only an annual rebalancing.
JW
Reply
Inflation may not cause the value of gold and silver to increase, but it is my understanding that central banks and Asian people are buying a lot as a traditional store of value that is more reliable than the dollar and other currencies.As a result the value of gold and silver should not fall much and may increase.
Reply
Your logic is simplistic and anachronistic. In 1980 China wasn’t the economic force it was today as are many other countries like Vietnam, the Phillipines. Africa is breaking out as is the mid east. Furthermore central banks weren’t printing money like crazy as they are doing today and now they are net buyers of gold. China and Russia are buying up gold hand and fist. Demand for platinum and silver is rising. It’s not just the world population that counts but the amount of economic activity that they are involved in. To compare 1980 to what is going on in the world today in relation to commodities is ridiculous.
Reply
The big difference now compared to previous commodity cycles is the 2 billion people in Asia moving from third world living into first world living standards – all at the same time.
That has never happened before and it will keep commodity prices stable or rising for over 20 years – until most of the 2 billion are living in first world standards.
Reply
Alex, I like to agree with you and I like your advice. But as Mrs. Murphy says. What about those billions and billions of printed dollars?
Our economy can’t grow enough to accomodate them.
Do you ever think the Federal Reserve will sell them back to the market and possibly tank an economy? No way. The politicians have too much control over the “Independent” Federal Reserve.
I think that gold will hit 5000 dollars per oz. in the next few years. Hopefully, gold miners with proven reserves will go right along with them. I have about 10 percent allocation for it.
Regards, Doug Fortney
Reply
I always value your advice, but you seem to be tacitly saying that the long term effects of staggering, unprecedented levels of debt won’t have a negative, long term impact. Also, what about Bernanke’s artificial lid on interest rates? Is this not a boiling pot with repercussions?
Reply
What happened in the GFP’s 2012 performance that it came in under the S & P 500′s? The Vanguard funds in the portfolio did well, with the exception of the Precious Metals & Mining, so what happened? I have been hoping you would discuss this since the beginning of 2013. I do not know how to make sense out of it. Please solve the mystery…
Reply