Commodities are my favourite asset class in the current environment. If you have read this blog before, it is quite possible you already know that. I constantly find it hard to explain to people that it is very smart to own commodities, but they argue against it. I also do not understand why many people hate this asset class, so I thought I would answer some common myths about the current commodity secular bull market... let us start!
1. Why invest in commodities when they follow stocks?
During bad economic conditions, like we are experiencing in current times, clueless investors will tell you that high commodity prices are not sustainable and that you would be crazy to consider investing into commodities as they fall with stocks. On top of that, media will try and brainwash you with the risk on / risk off correlation talk, so majority of retail investors will think that as soon as the economy slows and stocks start falling, commodities will crash too. But that is far from truth. Commodities have been great performers during current turmoil and that has always been the case throughout history.
The chart above shows that commodities do amazingly well during the periods where secular bear markets create sideways trading ranges in the stock market. So in other words, commodities do amazingly well during the periods of awful economic growth, during either high inflation or deflation, during debt problems and during periods when governments and banks fall apart. Commodities do well during constant recessionary periods like the economy experienced in 1900s/10s, 1930s/40s, 1960s/70s and 2000s/10s. Whenever global economies where in terrible shape - commodities did great - not the other way around.
Sure, commodities experience cyclical bear markets and corrections during their secular rises. For example Crude Oil has fallen by more than 50% over three times in a recent decade. However Brent Crude is still up 11 times in a 11 years. Silver has crashed many many times by over 25 to 30% and during 2008 it crash by almost 70%, and it is still up over 8 times since a decade ago. That is how markets work and that is why you should buy low like a contrarian.
2. "They say" the commodity bubble is about to pop?
What bubble? So many people have no idea what they are on about and even less ability to detect a bubble. "They" call everything a bubble - every week new asset class is in a bubble according to CNBC or some random deflation blog. So what is actually a real bubble? A real bubble or a speculative mania is something everyone talks about regularly, but not only that. Bubble is something that everyone talks about and owns (buys and sells), but not only that. Bubble is something that everyone talks about, owns and is making money on constantly because prices only go up. If you really want to understand what a real bubble or speculative mania feels like, instead of just stupidly throwing that word around everyday, you should watch a four part episode by PBS from 1997 on the Nasdaq Bubble (Article: The Greatest Bull Market Bubble Of All Time). I highly recommend it!
Look at the chart above, showing the asset portfolio of an average millionaire around the globe. How many of them do you think own Gold, Rice, Crude Oil, Sugar or a Commodity index fund? How many people do you know who own Soybeans right now? Do you know any farmers who have been making a killing on the farm season after season after season? No... agriculture has been an awful sector of business for 30 years.
Today, farms are deserted places. UK farmers have the highest suicide rates in the world. Many hundreds of thousands of Indian farmers kill themselves everyday as they go bust. In Japan, farmers are over 68 years old as young people have all moved to the city and refuse to work on farms. In other Western countries many young people attend university getting business and law degrees. How many young people do you know who have studied Agriculture? When I finished high school in 2001, every one of my friends went to study IT. Today we have nothing like that in the commodities boom. How can that be a bubble?
How many pension funds do you know who own Gold? And what is their weighting towards it... 1% of the overall portfolio? Probably even 0.5%. I bet majority of the people reading this do not actually own any Gold or Silver, let alone other commodities. How many friends of yours are talking about Rice or Coffee, let alone making money in it? Don't believe me, get of your computer and go attend some investment forums. Ask some people what they own or have recently invested in. Less than 10% of people on average own commodities and they aren't really making a ton of money on it year after year, like during the Nasdaq bubble.
During the period between 1996 and 1999, so many people where making money on Tech stocks they never even knew anything about. The whole world was gambling in Tech stocks, buying and selling everyday and making a ton of money. The whole world lost the plot. Silicon Valley programers became millionaires overnight... for doing nothing. Lets compare Gold and Nasdaq in the chart above. How is Gold anywhere close to the Tech bubble? Calling Gold a bubble or a mania is actually a total non sense!
3. What will end the current commodity boom?
Well obviously it will be the final bubble stage. That's right... commodities will one day soon enter a bubble, just like stocks did in late 90s. That might be in a few years from now or that might be in several years from now. I cannot tell you when it will happen, because I am not a prophet. When you see people gambling in Gold and Silver as it spikes to insane levels on daily basis, like Nasdaq did in late 1990s (go and watch that PBS video), you will know we are close to the end of the run.
Also look at the first chart. Going back about 300 years of history, the shortest secular bull market for commodities was 15 years, while the longest was 21 years. The average is about 17 years or so. If we assume that the commodity bull market started in 1999 or even 2000 - as seen in the chart above - than we can say the current secular trend has lasted about 11 to 12 years. That means commodities could rally for at least a few years more as a worst case scenario or a decade as the best case scenario.
However, I could also tell you what will end the boom or at least signal that the end is near - demand and supply. I commonly hear this... "my friend who follows markets said to me Oil is in a bubble because US and Europe are in big trouble. You should also short Oil like me because it will crash due to economic recession and deflation." No offence, but your friend is an idiot and so are you. Yes I agree that Oil collapses for awhile when we have economic pain, but Oil is up 11 times since 2000 and S&P 500 is up 0 times... so yes your friend is an idiot.
US, EU and UK have almost nothing to do with the Oil market as well as the overall commodity sector. It is the rest of the world, including the 3 billion people in Asia, that are in control of the rising demand and therefore the price of commodities. This is where the action is, this is where the growth is and this is what is setting the tone to the current secular bull market. There is a whole new world growing in the East, but the US and EU centric economists and investors fail to recognise this. They constantly point to the US consumer or the US Oil demand or the US GDP growth as a barometer of everything on our Earth. That is, once again, non sense. Asia is consuming the Soybeans, Crude Oil, Copper, Sugar, Cotton and Rice. Asia needs more Corn, more Natural Gas, more Uranium and their central banks need more Gold. Asia is starting to like chocolate so they want more Cocoa and they are starting to drink Coffee regularly like Westerns do.
Part II of the post will be covered later in the week, including the Supply side shortages that "no one" seems to see.
Yeah, but for individual investors, now there are really a lack of ETFs that track individual commodity prices for retail investors to join the bull market. I guess they will spring up more a few years later when the secular bull market is near the end. For retail investors, the best way is really still to buy physical gold and silver when prices correct.
ReplyDeleteDue to the central bankers' current reluctance to print more money, the world equity markets will fall back down to seek fair value. This may cause collateral damage to commodity prices. My feeling is that when official US inflation figure falls back towards 1%, and S&P 500 breaches 1000, the Fed will garner enough political backing to start QE3. Things will get worse before they get better. So, it maybe better to hold off buying first until clearer signals about QE3 is given out. :)
ReplyDeleteNevertheless, cocoa seems to be bottom. Maybe start here. :) Wheat and cotton have not given as strong buy signals as cocoa (especially for cotton, bullish sentiment still a bit elevated to warrant a buy).
ReplyDeleteCome on Tiho ! Buy APPL : worldwide diversified company, everybody want an iPhone, this company is a killer, you can only make money buying APPL! ;)) sarcastic...
ReplyDeleteAnonymous #1: right, but you can get some interesting ETFs right now, from ETFS http://www.etfsecurities.com/en/welcome.asp some iPath ETF, and Teucrium too. With additionnal work, you can play stocks in this sector.
Fred
Yes Fred, ETFS seems to offer a wide range of leveraged and unleveraged ETFs on individual commodities. However, many of them suffer from low trading volumes. Even for a retail investor like me, I find it difficult to enter and exit at times :)
ReplyDeleteETF is not like a stock. ETFS is the counterpart of your trade, not another investor! I mean not directly at least. No matter the trading volume, the issuer is bringing the liquidity.
ReplyDeleteWhen you buy an ETF, ETFS issue new shares representing the volume you bought, and with your amount, atomatically cover in the real underlying market (CORN futures for exemple + cash account) to achieve the appropriate leverage (for 1 (10% futures - 90% cash holding) 2 (20% fut - 80% cash) ...). You dont need someone to sell the ETF at the same time. It is the same when you sell: ETFS buy you back the shares by debit the cash account and closing the underlying future. ETF is a different mechanic than traditional stocks!!
Unfortunately, in most trading program, you only have the settlement price (meaning the price at which the transaction had given place). For very illiquid ETF, there can be only few transactions a day, and the ETF looks like always gaping.
Trading volume doesnt matter with ETF, the only thing that matter is the bid-ask at the price provided by the issuer...
Fred
The triangle in the SP 500 has broken to the downside strongly. Is it short city time?
ReplyDeleteAnonymous - The triangle HAS broken to the downside strongly. It seems many traders have piled into it. Why do I say that?
ReplyDeleteBreadth wise 10 Day AD Line is now in oversold territory, which usually does a great job calling intermediate bottoms. 10 Day Up/Down Volume is showing the same type of readings. Therefore, the down pressure has been extreme as of late and this to me reassembles more of a bottom than a further bearish outlook where one would chase the short side.
Indicators work until they do not work and prices sometimes tank even further. So no one is ever 100% of anything. Having said that, I think the shorting game and the bear market is done for now. I'd expect some buying very soon, depending on when the market bottoms... say either today or in a few days or in a week.
Also keep in mind that according to statistics, a large loss after breadth becomes oversold and down pressure enters extreme readings is very very rare. Actually it has happened only two other times in the past decade apart from today. That less at least to a rebound or a short term rally of some type, so either way I'd be a contrarian here!
Wow, I was expecting much more negativity in the comments page from deflationists who constantly post links about Treasury Bonds. What happened... where are they?
ReplyDeleteFred - your comment is great as always. How could I forget Apple? Geez *slaps head*! I should probably buy that like 500 other hedge fund managers, all of whom will be tripping over each other to sell once earnings disappoint. On a more serious note, I actually use ETFS every now and than. Last time I bought Sugar, I did it through an ETFS product. This makes life a little easier for retail investors. Also as someone already mentioned, Gold, Silver, Platinum and Palladium trade at spot prices, so those are much easier to buy and sell.
Anonymous #2 - I disagree with the QE3 comment. Sure QE3 will create a reflationary trade uptrend, but you do not need to hear the QE3 signal to pick a bottom and buy low. Bernanke talked about QE2 at Jacksons Hole at the end of August 2010 and the S&P 500 bottomed. However... Agriculture bottomed in June 2010 and already started a super rally. By late August 2010, you already missed a 3rd of the rally. That provers that commodities move more towards demand and supply, while the money printing is just fuel on fire!
Anonymous #3 - all agriculture is at a bottom right now. You should consider buying it right about now if you are interested in investing in commodities. I think DSI is now at single digits for every single grain and almost every single soft commodity. There is no more bulls left anywhere... only bears, deflationists and haters!
triangle break to the down side a fake out? if it is obvious, it is obviously wrong?
ReplyDeletegood comments-are u goin' long?
@Tiho: "I think DSI is now at single digits for every single grain and almost every single soft commodity." And close to the resolution of large consolidation patterns...
ReplyDeleteFred
Tiho, you need to beware, cotton DSI bullishness on 15-Nov-2011 was still at 33%, its Market Vane Bullish Consensus on the same date was still at 42% (33.33% higher than the 24 month low of 15%). In addition, the cotton price has not yet fully retraced its exponential upward move yet and is kinda starting its 5th wave down now. So, use tight stops with your cotton position.
ReplyDeleteI already got stopped out of Cotton earlier as I tightened my stop loss to a recent low.
ReplyDeleteI know I haven't updated my portfolio as of late. That is because I have been busy with other things including blog posts. On top of that I'm redoing the portfolio page.
I'm just waiting for some things to finish with my new broker in another country, before I start executing trades and investments. Unfortunately I am a bit stuck with some final paper work this week. I'll have a proper monthly performance track page as well as investments I make from say... next week onwards.
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ReplyDelete