Hot Commodities
Carlton Meyer

In 2004, one of Wall Street's most successful players, Jim Rogers, published an interesting book entitled “Hot Commodities” where he announced that commodities had begun a bull run that would last over a decade. Rogers' timing was perfect as commodities have soared over the past two years, providing returns many times higher than stock markets. However, Wall Street remains negative on commodities because their ascent raises costs for business and that hurts profits.

Wall Street and their unofficial sales reps at MSNBC and Fox News dismiss the rising values of commodities to focus on starting another “tech boom,” where stocks soar regardless of fundamental valuations. As as result, investors often see “experts” in the financial media predict that commodity prices will fall sharply, to the delight of their Wall Street advertisers. These analysts ignore fundamentals that show demand outstripping supply for many years. They inform the public that prices will fall because they are “too high.” However, the long bear market for commodities in the 1980s and 1990s led to a severe under investment in raw material production. Prices are high because of shortages, and will push higher until more supply becomes available.

Soaring commodity prices have caused a surge in investment to expand production, yet material from these investments will not enter the market for many more years. It takes from 5-15 years to increase production of basic resources. It is obvious that metals are not discovered one day and extracted the next because mines take over a decade to develop. Even simple items like coffee and live cattle require years to increase production. Jim Rogers predicts the current commodity boom will result in huge profits for commodity investors because of strong demand from China. This has proved correct as the Chinese continue their economic progress and recently predicted a 10.7% growth rate for 2007.

Rogers' book explains commodity cycles, and how all indicators point to a long rise in commodity prices. He cites a 2004 study from the Yale School of Management's Center for International Finance, “Facts and Fantasies About Commodity Futures,” which shows an inverse relationship between commodity prices and the overall stock market. It reveals that since 1959, commodities futures have produced better annual returns than stocks and outperformed bonds even more. There is a continual cycle where stock market values grow as the economy expands until the resulting strong demand for commodities out paces supplies and causes raw material prices to rise. This slows growth and stagnates stock markets for over a decade until investments to expand commodity production flood the market with new supplies. Conversely, this causes commodity prices to plummet resulting in an economic boom that unleashes a stock market bull.

Each commodity moves at its own pace. Commodities like oil are non-renewable, so increasing production becomes more difficult each year. During this decade long boom, there will be months and even years in which prices remain flat or decline before climbing sharply upward again. For example, oil prices have remained flat for over a year while copper prices recently fell. 2006 was a great year for most commodities, especially metals: Nickel +144.0%, Zinc +121.5%, Tin +79.3%, Lead +57.3%, Copper +44.0%, Silver +42.0%, Aluminium +23.3%, Palladium +22.3%, Gold +19.8%, and Platinum +13.7%.[1]

Rogers' book explains the complexities of the commodities markets and recommends buying into a commodities fund. Having researched the few commodity funds on Wall Street, he determined they were outdated or imbalanced and formed his own fund in 1998 based on his Rogers International Commodity Index (RICI). For those wishing to invest directly through commodity contracts, Rogers' book provides a tutorial. All of Rogers specific recommendations from 2004 (oil, lead, gold, sugar, and coffee) soared in value. However, he warns that placing all bets on just a couple commodities is risky.

Since commodity exchanges have comparatively low margin rates of just 5-10%, it becomes easy for investors to become gamblers and lose everything. This results in horror stories about the risks of investing in commodities that deter most investors. As a result, most stock brokers advise against commodity investments, although the Yale study showed that commodities have historically produced three times their return. This is because much of the profit generated by companies listed on stock exchanges is lost through poor management, debt repayment, taxes, royalties, executive pay and perks, and sometimes accounting fraud.

On the other hand, commodity markets are more complex than stock markets, and most contracts are less than two years. This requires a continual turnover of positions, costing investors fees and cutting into their gains. As a result, Rogers admits that most commodity contracts lose money for the investor, but that is more than offset by large gains on other contracts. In contrast, most stocks pay dividends and can be held for decades while the resulting capital gain from stock appreciation remains tax free until sold.

One can invest in commodities indirectly through commodity producers like mining companies.[2] Another method is to invest in the few mutual funds dedicated to natural resources. In recent years, it has become possible to invest in physical gold and silver directly through Exchange Traded Funds (EFT)s. Gold is a solid investment,[3] although silver should perform better.[4] Oil EFTs exist, but not in the form of direct physical holdings. Their value is based on complex contract trading that allow fund managers to quietly siphon off profits should they choose, and results in unusual tax treatments.[5] It is probably better to invest in oil companies with significant reserves, especially mid-size companies that are likely to be purchased by bigger ones.[6] Whatever method of investing in commodities one prefers, all are better than betting on the U.S. Dollar in the form of U.S. securities, corporate bonds, or bank deposits.

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[1] “Major base and precious metals all up in 2006. Where to in 2007?”; Mineweb ; Jan. 2, 2007.

[2] “Investing in Metals ”; SRA; Sept. 26, 2006.

[3] “The Tethered Gold Market ”; SRA; Nov. 14, 2006.

[4] “The Silver Shortage ”; SRA; July 24, 2006.

[5] “Getting sophisticated about crude”; Marketwatch ; Dec. 10, 2006.

[6] “Buying Oil Reserves ”; SRA; Aug. 15, 2006.