• Table of Contents
• Read an Excerpt

Table of Contents

Read an Excerpt

Chapter 1

The Next New Thing Is—Things

A new bull market is under way, and it is in commodities—the “raw materials,” “natural resources,” “hard assets,” and “real things” that are the essentials of not just your life but the lives of everyone in the world. Every time you walk into the supermarket or the mall, you’re surrounded by commodities that are traded around the world. When you get into your car or truck, you are surrounded by other widely traded commodities. Without the commodities “futures markets” to set and regulate prices, the things we all need in life would be scarce and often too expensive. These essentials include oil, natural gas, wheat, corn, cotton, soybeans, aluminum, copper, silver, gold, cattle, hogs, pork bellies, sugar, coffee, cocoa, rice, wool, rubber, lumber, and the 80 or so other things listed in the traders’ bible, the Commodity Research Bureau (CRB) Yearbook.

Commodities are so pervasive that, in my view, you really cannot be a successful investor in stocks, bonds, or currencies without understanding them. You must understand commodities even if you only invest in stocks and bonds. Commodities belong in every truly diversified portfolio. Investing in commodities can be a hedge against a bear market in stocks, rampant inflation, even a major downturn in the economy. Commodities are not the “risky business” they have been made out to be. In fact, I believe that investing in commodities will represent an enormous opportunity for the next decade or so.

For most investors, commodities trading is a land of mystery full of legendary dragons.Intelligent, well-informed people who can recite P/ E ratios of large caps and small caps, who study the balance sheets of high techs and biotechs, semiconductors, and small banks in the South, self-proclaimed “savvy investors” who follow bond prices and yields more closely than the baseball box scores and who might even have an eye on the dollar versus the euro, the yen, and the Swiss franc, know nothing about commodities. And if they do know something, it’s typically second- or third-hand information, usually mistaken, and, more often than not, involves a cautionary tale about “a brother- in-law who lost his shirt in soybeans.” Like Americans who never travel to foreign countries for fear of being humiliated or cheated because they don’t know the local language and customs, investors who shy away from commodities are missing out on an incredible opportunity.

You cannot ignore an entire sector of the marketplace—not if you really want to be considered an “intelligent investor.” If a friend of yours who was heavily invested in the stock market went through the 1990s without even considering buying a technology stock, and ignored what was happening in the world of Microsoft, Cisco, Amazon, eBay, and even IBM, surely you would find such behavior strange. Yet that is precisely what most investors have done with respect to commodities.

One reason that companies and stocks did so well in the 1980s and 1990s was that raw materials were in a bear market: Cheap commodity prices removed the cost and margin pressures from companies that depend on natural resources to do business. Investors who figured out that the commodity bear market was ending in the late 1990s realized that the stock bull market would be ending, too. The CNBC anchors were still giggling with glee, still advising to buy more dot-com shares, while the smart investors were exiting the market and moving to commodities. They could see that the costs of doing business would soon start eating away at profits—and that stock prices would soon follow.

It is hardly the bush leagues. In fact, natural resources are the largest nonfinancial market on the planet. The annual production of just 35 of the most active commodities traded every day in New York, Chicago, Kansas City, London, Paris, and Tokyo is worth $2.2 trillion. The volume of dollars traded on the commodities exchanges is several times that of the common stocks traded on all U.S. stock exchanges. (Commodities dealings for many times more than that amount take place outside the commodities exchanges.) And wherever there is a market, there are opportunities to make money. I know—the business pages of your newspaper, the financial magazines, and CNBC devote most of their time and space to stocks. According to the media and other stock-market “experts,” the equities bull is forever hiding just around that next corner on Wall Street. But millions of investors who listened to the experts back in 1998–2001 about “the New Economy” got hammered in the stock market and are still trying to get back to even. The smart investor looks for opportunities to acquire value on the cheap, with one eye out for a dynamic change in the offing that might make that investment even more valuable.

Today, commodities fill both bills. The commodity bear market ended in 1998, when prices were approaching 20-year lows (equal to Depression levels, when adjusted for inflation). That year Merrill Lynch, the largest brokerage firm in the U.S., decided to leave the commodities business, and I began a commodities index fund to capitalize on the end of the bear market.

I am convinced that value and strength in the commodities markets will continue for years to come—that we are, in fact, in the midst of a long-term secular commodities bull market. The twentieth century saw three long commodities bulls (1906–1923, 1933–1953, 1968–1982), each lasting an average of a little more than 17 years. The new millennium has begun with another boom in real things. In my opinion it began in early 1999. The aim of this book is to explain why, showing, along the way, how to profit from it. Better still, by understanding natural resources, you will become a better investor in every other asset class.

There is no mystery to it. What could be more straightforward in this world than its very basic materials? Corn is corn, lead is lead, and even gold is just another thing whose price depends on how much of the stuff is around and how eager people are to own it. And there is certainly no magic to figuring out the direction in which prices will go in the long term. These alternating, long bear and bull markets in metals, hydrocarbons, livestock, grains, and other agricultural products do not fall from the sky. They are prime players in history, the offspring of the basic economic principles of supply and demand. When supplies and inventories are plentiful, prices will be low; but once supplies are allowed to become depleted and demand increases, prices will rise, just as inevitably. It has not taken any genius on my part to understand this dynamic; it’s just the way the world works. But the investor who sees this supply-and-demand balance going out of whack and is willing to put some money on the table will be rewarded manyfold.

We are now in one of those periods when a new bull market is under way —and it is in commodities. And when that happens it’s time to get a lot more money into things. Do you see another alternative for your money that I’m missing?

• Stocks. Most equities are overpriced on a historic basis; P/E (price-earnings) ratios for the Nasdaq are in the stratosphere. In fact, at every level of consideration—price-earnings ratios, price-to- book ratios, dividend-yield ratios—corporate equities are all extremely expensive compared with past markets. Do you really think stocks will be able to soar from such exalted levels?

• Bonds. With interest rates lower than they’ve been in decades, the bond market is not about to make you rich—especially as rates go up. The yields on long-term government bonds are pathetic, while better- paying corporate bonds are expensive. And if your financial consultant advises you to buy bonds issued by the “government- sponsored” mortgage agency Fannie Mae or Freddie Mac, hang up the phone. The White House, Congress, HUD, and federal regulators are all gunning for both agencies. Sitting on top of $7.3 trillion in home mortgages, Fannie and Freddie are scandals in the making. (N.B.: “Government-sponsored” does not mean “government-backed”; if either Freddie or Fannie goes down, Uncle Sam is not obliged to give you your money back.)

• Real Estate. Housing is already too expensive to be much of an investment, at least in those places where you’d be willing to live. (You’ve even missed the real-estate booms in the U.K., Spain, Australia, New Zealand, and other countries where prices have accelerated beyond their historical average rates of increase.) U.S. housing prices rose faster than the rate of inflation for more than eight years; home-equity values may be inflated by as much as 20 to 30 percent. In New York and Southern California, housing prices have doubled in the past five years. A massive speculative bubble in the U.S. housing market seems to be floating from coast to coast, and as it bursts (as bubbles always do) some serious pain is in store for the millions of Americans who have been borrowing against their home equity at record rates—$750 billion in 2003. The resulting loss in wealth could be between $2 trillion and $3 trillion, sparking an economic downturn reminiscent of the one that resulted when the dot- com stock bubble went kaboom. Even if the air stays in the real- estate market, prices are way too high for investors to make a lot of money.

• Currencies. The U.S. is already the world’s largest debtor nation— with more than $9 trillion in outstanding international IOUs, and increasing by $1 trillion every 15 months. For the past 20 years, we have been borrowing heavily in the world’s financial markets to finance large trade deficits—now about $700 billion a year (or 6 percent of GDP, the highest ever). Our interest payments to service those debts in 2005 alone totaled $350 billion. That’s roughly a billion dollars a day just to keep the dollar afloat. We are now living off other people’s money. With the White House in a race with the Federal Reserve to spend money faster than the Fed can print it, the dollar is shakier than ever. Foreign investors eyeing our balance sheets are beginning to see a banana republic emerging on our shores, and many have already bailed. (In the 12-month period between June 2003 and June 2004, net foreign investment in the U.S. was a negative $155 billion.) During past trade deficits, it was foreign investment that financed our standard of living; now it’s being paid for by foreign buyers of U.S. bonds—mainly Asian banks, including the Chinese —looking to keep their own currencies under control. Should those lenders decide that they would rather not finance our profligate ways, the dollar will decline even more, interest rates will rise, and so will inflation. Foreigners have already begun to sell U.S. dollars. But to where do you run? The Swiss franc and the Japanese yen are stronger than the dollar, but those governments are also playing monetary monopoly, fiddling with the money supply and the interest rates to make their products more competitive. If you had changed your dollars for euros at the end of 2001 when the euro was worth 89 cents, in September 2006, your euros would have gone up to $1.27, a very nice 42 percent gain. But the euro, too, is a flawed currency long-term. If anyone has a fix on a great currency, let me know.

Commodities, in fact, have been outperforming stocks, bonds, and real estate for years now. The Rogers International Commodities Index, which I founded, was up 254 percent eight years after its start on August 1, 1998, while the Lehman Long Treasury Bond Index was up only 67 percent and the S&P 500 Index of major stocks was up 32 percent. After a seven-year period ending in 2006, of the two stock mutual funds with the most assets under management—the Vanguard 500 Index and Fidelity Magellan—Fidelity’s was in negative numbers and Vanguard was up only 35 percent after seven years.

How do your stocks stack up against these gains in commodities? Of course, you might be a much more talented stock picker than most. But even if you’re an absolute wizard you ought to be putting some of your winnings into commodities—or companies and countries that produce them—if only in the interest of being genuinely diversified.

I suspect that the prospect of immersing yourself in the ups and downs of soybeans, sugar, cotton, crude oil, or even gold might not strike you as “fun.” Admittedly, I have often relished buying a great company cheap and holding it long-term; to be sure, finding the next GE, Microsoft, or Amgen can be an intellectual as well as a profitable adventure. But let me assure you that when the price of sugar futures went from 1.4 cents to 66 cents between 1966 and 1974, those holding cheap sugar had a whole lot of fun watching sugar rise more than 45 times. Back in the 1970s, when oil went from $3 a barrel to $34 in just six years, man, that was where you wanted to be! Those who invested in commodities in 1998 made nearly 254 percent eight years later.

I don’t know about you, but for me that’s fun.

Open Your Mind—to Commodities

A friend of mine recently called his broker at a major New York investment firm to discuss moving a modest chunk of his portfolio into commodities. “You’re aware of how risky commodities are, right?” she said. He said he was aware of the risks involved in investing in anything. The broker took that as a “No,” and proceeded to tell a story about her colleague who had “one of the big corner offices” on the same floor. “He was heavily into commodities,” she said. Then, after a pause pregnant with the offer of some wise, free advice, she whispered, “He’s no longer with the company.” When my friend insisted that he still wanted to explore commodities, she confessed that she couldn’t help him; she had never bothered to get her license to deal in commodities, mainly because there had never been a good reason to do so. After a bull market in stocks that has lasted longer than the careers of many of today’s financial managers and consultants, not to mention the journalists who feed off them, it is understandable that most investors and their advisers have trouble wrapping their minds around the prospect of investing in commodities. The last time serious money was being made in commodities, these people were in college or maybe even junior high school. Some may even have been in diapers.