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Commodity Investing: 6 Ways to Profit & 2 Pitfalls to Avoid
By Dr. Steve Sjuggerud, President, Investment U
Friday, August 29, 2003: Issue #269
“Commodities will do well for years, while stocks, recovering from the bubble, will do little.”
-Legendary investor Jim Rogers, in his new book Adventure Capitalist
Gold at $375 an ounce is fast approaching seven-year highs. Oil prices have nearly tripled since early 1999. Lumber prices are up nearly 50% from their lows< in the last three months.
Even better, investments in these commodities have soared. Gold stocks as a group (as measured by the Gold Bugs Index)are up over 60% since April. Smaller commodity stocks have done even better. At a time when stocks appear both boring and expensive, commodities are hot and don’t look like they’re going to cool off anytime soonThe Reasons To Buy Now
So today, we’ll talk commodity investing. Specifically, I’ll share with you six distinct ways to invest in them (and I’ll direct you to one particular commodity-based investment that savvy investors believe could make you several times your money in a very short period). And I’ll also warn you of the two pitfalls that many investors overlook when they learn about a hot commodities opportunity. Let’s get started
Jim Rogers says, “We now have a classic change. Raw materials supply and demand are out of whack again, and inventories are down. Commodities will do well for years, while stocks, recovering from the bubble, will do little The new commodity bull market has started, but few realize it yet, just as few recognized that a new bull market in stocks had started in the 1980s”
But Jim cautions that this commodities bull market will not last forever. So we need to get on board now. “Someday in several years we will have to sell our commodities and go back to stocks” As for how to tell when we’re reaching a peak in commodities, Jim answers, “When Merrill Lynch goes back into the commodity business sell out [your commodity investments] and buy stocks.”
Commodities have a lot going for them now. As they are “real” assets, they are a great investment at a time when a government is creating inflation (making paper money worth less). Also commodities often do the opposite of stocks. Stocks had nearly a 20-year bull market ending in 2000, while commodities did nothing in that same period. But 30 years ago, when stocks weren’t doing anything, commodities were where it was at.
Since commodities haven’t done a thing for decades, most investors don’t think it’s possible to make money in them. But after such a long period of lean times, the companies in these industries had to become extremely efficient to survive until today.
Commodity Investing: The Six Ways to Profit
There are six major ways when commodity investing. Here they are with, along with a resource on how you can get more information on each (or even invest):
- 1. You can invest in a broad based, no-fee mutual fund that holds commodity-type companies (your top choice is probably the T. Rowe Price New Era Fund (PRNEX), with five stars from Morningstar).
- 2. You can get more specific, and own a narrowly based fund, like a gold fund (one of my personal holdings is Frank Holmes’ U.S. Global Gold Shares (USERX) – it’s been around for 30 years).
- 3. You can get more broad and limit your fees through I-shares (www.ishares.com) which act like index funds. There are three different natural resource/energy based I-shares. All of these own stocks that could benefit from an increase in commodity prices.
- 4. You can go the “managed futures” route. These are funds that attempt to profit from both the rise AND fall of commodity prices. They don’t invest in stocks at all, rather they trade in the futures markets, picking out trends and riding them. The historical track record of these investments is actually fantastic – literally stock like returns with less risk over the very long run. These are beyond the scope of today’s letter, but if you’re interested, a good man to contact is Bob Meier (bobmeier@bellsouth.net).
- 5. You can trade commodities directly (instead of through a stock), and the typical way is through trading futures or futures options. This is also beyond the scope of today’s letter. But readers have been happy with Sue Rutsen’s 20 years of options experience and good personalized service (srutsen@foxinvestments.com).
- 6. Lastly, you can buy an individual stock poised to benefit from the sector. As a general rule of thumb, the smaller the company offering the stock, the more speculative the opportunity is – but that also means you stand to make a lot bigger profit as the commodity rises. You’re not going to make six times your money in ExxonMobil in a year, but you might in a small commodity-oriented stock. And an analyst I trust has uncovered such an opportunity I’ll tell you how to get more information on in today’s Cribsheet.
Two Big Commodity Investing Pitfalls
The following two pitfalls are an inherent part of investing in commodities.
1. “The truth is that the price of virtually every commodity-agricultural, mineral, and energy-has fallen steadily throughout the 20th century relative to wages.”
Julian Simon said this in his outstanding study The Greatest Century That Ever Was: 25 Miraculous Trends of the Past 100 Years. (It is one of the most important papers in recent history. I strongly suggest that you print it out and read it – and then give it to your kids to read. For information on how to do this, see the Crib Sheet portion of today’s E-Letter.
What Simon is saying is the brutal truth that most commodity professionals don’t want to hear – that commodity prices of all kinds – agricultural, mineral, and energy prices, have continued to fall relative to incomes over the very long run. Simon mentions each type:
For agriculture, Simon points out that Wheat prices fell by 95% relative to wages in the 20th century. For metals, the price of many “have fallen an average of fivefold since 1900.” For oil, at the time he wrote the paper, Simon said, “Fifty years ago the world had about 20 years’ worth of known reserves of oil. Thanks to technological innovation, which is outstripping the pace of depletion of reserves, the world now has at least 50 years of reserves.”
The ultimate point to remember is that, while commodity prices may rise in the short term, the historical trend of commodity prices relative to wages is lower.
2. Don’t fall for the “cost of production myth”
Consider this: what would it cost you to make an old typewriter? What is its cost of production? That’s a lot of moving parts and heavy metal – a few hundred dollars? I don’t know.
Now consider this, in the age of computers, what is that typewriter you built actually worth? Certainly not it’s cost of production. The same is true in commodities. Since the mid-seventies, sugar has sold below it’s cost of production much of the time. As Jack Schwager says in the book Schwager On Futures, “No matter how many times this old saw is disproved by actual events, it never seems to be laid to rest.”
Commodities are hot now. There is a place for them in your portfolio. And by knowing the six major ways to invest in them, as well as the two pitfalls to avoid, you now have the basic tools you need to begin adding commodities to your portfolio.
Steve
- Four Easy Ways to Trade the World’s Top Commodities
- The Best Ways to Play Oil, Gold and Frozen Florida Oranges
- Gold and Oil: Why These Two Commodities Are Set to Blast Higher in 2010
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