Commodities: The Asset Class Of The Future?

Although commodities only make up a small fraction of most funds, there is growing interest in this new asset class. While some investors don't think commodities should be considered an asset class, the growing demand and shrinking supply of the world's resources should make commodities a very interesting space to watch. For more, see the following post from Tim Iacono's blog.

With the price of oil now plummeting - just $62 a barrel as this is written - the commodity bulls of the world may need some "positive reinforcement" regarding the longer-term picture for this asset class and the Financial Times is happy to supply such in this report.

Commodities: Cinderella class slowly gains allure
The world of commodities, encompassing everything from gold to pork bellies, emerges as a real Cinderella asset class in the Watson Wyatt survey. Of the $872bn (£527bn, €621bn) held in alternative assets on behalf of pension funds by the 100 largest managers, a meagre 0.4 per cent resides in commodities.

David Hoile, head of asset research at Watson Wyatt, believes the asset class is not quite as unloved an ugly sister as it first appears; the survey only picks up direct exposure to commodities, whereas many pension funds will also have exposure via vehicles such as multi-strategy and global macro hedge funds.

“Pension funds are likely to have a 5-10 per cent allocation to commodities,” says Mr Hoile, with North American funds much keener than their European counterparts. A slice of funds’ equity allocation will also be in commodity-related stocks, providing another element of exposure.

The low allocations are, in part, simply a result of history; commodities are a newer asset class than, for example, real estate or private equity.

It is notable that, with all the hand-wringing over endowment fund losses and the many asset allocation changes that resulted, there seems to be an almost unwavering commitment to the natural resource sector in general and commodities in particular.

Of course, upcoming changes to the regulatory environment and tarnish on the Goldman Sachs/JP Morgan stars may change all that.

I'll never forget an email I received about a year ago, something to the effect of, "I have been on the Street for 20 years and I know to stay away from commodities".

Well, that's changing, despite the protestations by some that it is not a real asset class.

Philippe Comer, head of commodity investor solutions for the Americas at Barclays Capital, says it is only in the past decade that financial investors have entered a market still dominated by the producers and consumers of commodities.

Mr Hoile adds: “The financialisation of commodities by institutional funds was something we only really started to see from 2001-02. The modest allocation currently reflects that fact that we are at the start of a trend.” But there are also deeper forces at play that even a particularly benevolent fairy godmother would struggle to wish away; both the rationale for investing in commodities, and the mechanics of how any exposure should be generated, are questions still up for debate.

Mr Comer reports that institutional interest has been driven by a desire to increase diversification and to hedge against the risk of higher inflation.

There's much more in this very good piece on historical cycles, the difficulties with yield roll, active management, and a number of other topics.

One of the big differences between the 1970s and today is that, back then, the returns on commodity investments also benefited from high interest rates as most investor money was directed toward fixed income investments, futures contracts typically costing 10 percent or less of the face value of a futures contract.

With today's freakishly low interest rates, that works against investors.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

How To Profit From Silver

Silver, like gold, is a highly volatile investment with wild swings in value. However if you believe that inflation, or even hyperinflation is likely, then silver may be a good commodity to consider right now. Brian Hunt from Money Morning discusses why silver is a compelling investment right now and how you can profit from it.

Late last month, one world’s greatest speculative profit plays made an important breakout move.

This speculative investment is the tiny group of mining stocks that operate as pure plays on the price of silver.

If investment assets were all patients in a mental ward, bonds would be the guy who sits silently in the corner and stares out the window. Stocks would be the guy who wanders the hall and mumbles to himself. And silver would be the guy they keep in the padded room all day.

And with good reason.

As the chart that follow shows us, silver prices are subject to fast, wild swings - up or down. You see, silver trades a little like a precious metal, meaning that it moves wildly when people get worried about a market crash or inflation. But silver is also an industrial metal, so it can trade up or down in line with changes in global manufacturing activity.



Okay, so you now know that silver can move crazily. Now realize the firms that focus on silver mining are pure madness. Their profit margins and asset values fluctuate with more volatility than silver itself. Take one of the largest and best-known silver companies, Silver Standard Resources Inc. (Nasdaq: SSRI).



When the global credit crunch hit last year, Silver Standard saw its share price plunge from $42 to less than $8 - a drop of more than 75% in just three months. But after investors warmed back up to mining stocks, it took the same amount of time to nearly triple in value.

And that brings us back to the present day.

Just last month, Silver Standard saw its shares blast to a fresh nine-month high. The global economy is getting "less bad" - and the aggressive bailout plans that are being rolled out throughout the world have most smart people scared to death of inflation. That’s driving the price of "real assets" - like silver - to the moon.

So the next time you’re looking around for an "inflation trade," consider going long on a company like Silver Standard - or taking a position in the iShares Silver Trust Exchange Traded Fund (ETF) (NYSE: SLV).

If the government’s “funny-money” scheme turns out badly, these positions have a long history of providing gigantic gains in virtually no time at all.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

More Gold News...

The World Gold Council just released the newest Gold Investment Digest, and it contains a lot of great information about Gold, and the Gold market. Tim Iacono walks us through some of the main points, and adds his own insight, in his blog post below.

Always a sucker for a good chart, particularly when it involves precious metals, the one below in the most recent Gold Investment Digest from the World Gold Council is a doozy.
The trade group's first quarter report on gold has some rather interesting statistics related to the quickly changing supply and demand situation.

As shown above, inflows to the many gold ETFs around the world have been brisk:

Investors bought 469 tonnes of gold via this channel, dwarfing the previous record, of 145 tonnes, set in the third quarter of last year. SPDR®Gold Shares (“GLD”) enjoyed the bulk of the inflows. The total amount of London Good Delivery bars held by the Trust increased to 1127 tonnes at the end of Q1 09, from 780 tonnes at the end of last year. The two Swiss listed gold ETFs (the ZKB Gold ETF and the Julius Baer Physical Gold Fund) enjoyed the next strongest inflows, rising by 37 tonnes and 32 tonnes respectively. Inflows into the gold ETFs continued to grow throughout the quarter, despite the downward correction in the gold price, indicating that, as in past price corrections, ETF holdings tend to be “sticky”.

It's kind of ridiculous just how big the SPDR Gold Shares ETF (NYSEArca:GLD) has become when compared to the nine other funds and they have certainly characterized the inventory correctly in light of recently faltering prices - "sticky" is the right word.

As noted here yesterday, just 23.2 tonnes of the almost 350 tonnes added earlier in the year have exited the trust as the gold price declined from almost $1,000 an ounce in early February to current prices of just over $900.

They had this to say about the many and varied rumors about trading on the COMEX:

The quarter was beset with stories either urging investors to take delivery of, or claiming investors had taken delivery of, large amounts of gold from COMEX, driven by widespread shortages of gold in the spot market. Some claimed that the COMEX warehouses might therefore run out of gold.

The reality was quite different. While there were (at times severe) shortages of coins and small bars during the quarter, there was no shortage of London Good Delivery Bars, the main trading vehicle in the global over-the-counter market. And with respect to COMEX stocks, both registered stocks on COMEX (gold which meets the standards for delivery and for which a receipt from an exchange-approved depository or warehouse has been issued) and eligible stocks (gold which meets the delivery standard but for which no receipt from an exchange-approved warehouse has been issued) increased over the quarter, to 2.94 million ounces and 5.94 million ounces, from 2.83 million ounces and 5.71 million ounces respectively. This took total COMEX stocks as a percentage of long positions to 38%, which is high by historical standards, rather than indicative of stocks that have been depleted by a run on physical gold at COMEX.

Geez... The folks at the World Gold Council should really get a hold of some of the officials over at the National Association of Realtors (NAR) to see how an industry trade group is really supposed to operate.

Here's a perfect example where they could add to the fervor over rising gold prices by citing some shoddy statistics about how the supply of gold is limited and "it's a good time to buy" but, instead, they pour cold water on one of the biggest stories this year in the gold community about the goings-on at the CRIMEX.

Maybe former NAR chief economist David Lereah could be hired as a consultant to help out.

The Gold Investment Digest goes on to discuss such important topics as gold's correlation with other asset classes, jewelry demand, mine supply, and central bank sales.

If you've never thumbed through this quarterly report, it really is worth a look.

Registration is required at the World Gold Council website to get a copy, but it's free.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Gold And Silver Update

Last week we saw some big news come out of China regarding gold, and investors are paying close attention. China almost doubled their gold reserves, and after a stretch of falling prices, this news sent prices up. For more on this, read the following post from Tim Iacono.

Big news for the precious metals markets came from China last week when the Xinhua News Agency published comments made by Hu Xiaolian, head of the State Administration of Foreign Exchange, indicating that China's gold reserves had increased by 454 tonnes since 2003. Apparently, they were required to report the new total to the IMF and made a public disclosure at the same time, however, it is not at all clear why there were no previous updates in recent years.

This almost doubled their previous reserve total of 600 tonnes and vaulted China into sixth place on the World Gold Council's list of official gold holdings as noted in this item last week. With almost $2 trillion in foreign exchange reserves and an increasingly vocal dislike of the U.S. dollar in recent months, this big gain comes as no surprise to most analysts, however, the magnitude of the increase in dollar terms was mostly overlooked in media reports.

This addition amounts to only $13 billion - less than one percent of their foreign exchange reserves - and boosts their "percent of reserves held as gold" from 0.9 percent to just 1.6 percent. The "rule of thumb" for western central banks is a stockpile of 15 percent, about ten times the new total, and most analysts expect thousands more tonnes to be purchased.

Prices for both gold and silver were buoyed by the news late in the week but, after two months of mostly lower prices, the metals were due for a rebound. For the week, the price of gold rose five percent to end at $913 an ounce and spot silver surged nine percent to close at $12.89 an ounce.

As a result of this move back up above the $880 level, buy indicators for both gold positions in the model portfolio - Gold Bullion and the SPDR Gold Shares ETF (GLD) - have been changed from green back to yellow.

It will be important to keep an eye on the world's most popular gold ETF since, for the first time this year, metal recently exited their vaults as shown to the right. Inventory has declined by 23.2 tonnes since April 16th after an impressive addition of almost 350 tonnes since the first of the year.
Interestingly, mainstream financial media outlets such as Reuters and Bloomberg now routinely report changes in GLD inventory in their gold reports and also compare their stockpile to official country holdings around the world, something that I've been doing for years. In fact, I remember being disappointed early last year about not being mentioned in an article in the Wall Street Journal after a reporter called to follow up on one of my articles about the GLD inventory passing China's official holdings of 600 tonnes.

It's was ironic to see these two items in the news together last week.

Buying in India has supported the gold price in recent days as the world's most price-sensitive buyers have been on strike for most of the year, only appearing when sub-$900 an ounce prices were to be had as Monday's important Akshaya Tritiya festival neared. This is one of the four most important days of the year for Hindus and is considered an auspicious day for buying long-term assets such as gold, a legend stating that any venture begun on Akshaya Tritiya will bring prosperity.

The recent surge in enthusiasm for the gold price, while welcome, should be tempered by the knowledge that, according to GFMS, about 500 tonnes of scrap gold entered the market during the first quarter of 2009. This is the equivalent of an entire year's worth of scrap metal and exceeds the record 469 tonnes added to gold ETFs around the world over the same period. While I'm sure that prices for precious metals will go much higher at some point, making such a move in the near term will be difficult absent another flight to safety, something that is now looking more likely than it did a few weeks ago.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Looking Back At 2008

2008 was a year to be remembered by investors, but certainly not in a good way. While most investors probably lost a substantial amount of money, hopefully they at least learned some powerful lessons. James Picerno from The Capital Spectator looks back at 2008 and some of the things investors should take away from it in his blog post below.

Two-thousand-and-eight is gone—and good riddance. But the blowback will be with us for some time, on a number of fronts. And that starts with reviewing the previous 12 months.

As our first table below shows, red ink was spread far and wide in 2008 in almost everything other than cash and bonds. Otherwise, double-digit losses were the rule last year. But if we look at the monthly tally for December, the view looks decidedly better. REITs, in particular, rebounded sharply last month, surging nearly 18% in December.

Most of the other asset classes followed suit, albeit with lesser although still robust gains for the month. The exceptions are cash and commodities. It's too soon to tell if the worst is over or if the rally is merely a fleeting affair in an ongoing bear market. But given the extent and breadth of the carnage, it's tempting to think that maybe, just maybe, positive returns await in asset classes other than cash.

Speaking of cash, a few words about last month's performance of 3-month Treasury bills (our proxy for cash) is in order. Although our table above lists December's performance for cash as zero, the number's in red because the return is slightly negative for 3-month T-bills if you carry the return out to two digits: -0.02%. In the grand scheme of the universe, no one will lose any sleep over this microscopic loss. But the fact that T-bills—the classic "risk-free" asset—posted a loss of any degree is extraordinary, and so it speaks to the times we live in.

Indeed, monthly losses in T-bills are so rare that it doesn't register in our databases, which admittedly only go back to the 1980s for "cash." That's not to say that it never happens, but you'll have to go back quite a ways to find monthly red ink in this corner of finance.

The source of last month's slight loss is no mystery, at least. The explanation starts by noting that the yield on a 3-month T-bill slipped to just about zero at the end of November—an astonishing state of affairs in and of itself. Then, in December, the T-bill yield rose a bit, albeit to a mere 0.11% by December 31 from roughly zero a month earlier. Slight as that is, it was enough to tip the monthly return to negative in the 3-month T-bill for two reasons. One, for much of December, the 3-month T-bill barely gave investors any yield to speak of, and since yield is the only source of return for these securities the pickings were fated to be slim at the end of November even under the best of circumstances. Add the fact that T-bill yields rose slightly set the stage for an ever-so-slight loss (rising yields translate into lower prices in bondland).

The fact that even cash could post a loss is a sign of the times, of course, although investors had bigger problems than worrying about miniature losses in T-bills. Indeed, as our second table below reminds, 2008 was a horrendous year for most asset classes. Horrendous, but not entirely surprising, at least in terms of how 2008 compared with previous years. Yes, the depth of the losses are shocking. But the reversal of fortune was overdue—long overdue in some cases.

click to enlarge

Consider emerging market stocks, which lost more than 50% last year. Shocking as the loss is, the volatility is not out of character for the asset class. Indeed, as the chart shows, emerging market stocks had been posting gains of 20% to 50% for each and every calendar year during 2003-2007. That extraordinary five-year stretch of price increases had to end eventually, of course, and for anyone who expected otherwise, well, they were living in a dream. Surely if an asset class can post a 50% gain in one year—as emerging markets did in 2003—something similar is possible if not likely on the downside.

A similar lesson applies to the formerly high-flying world of REITs, which also enjoyed an extraordinary bull market run that finally started coming apart in 2007 and continued in 2008.

Yet not everything was about losses in 2008, a year that witnessed potent gains for some corners of the bond world, which once again makes the case for owning a globally diversified portfolio. Foreign government bonds denominated in foreign currencies, for example, was an exceptionally bright light last year and so if you didn't own the asset class (via BWX, for instance), your portfolio probably paid a price.

The point is that cycles endure, even if the details aren't always 100% clear. What goes up in price eventually comes down. Meanwhile, lower prices precede higher prices. Although one must be extremely cautious about applying that view to individual securities, it generally works well over time when it comes to asset classes, which have a habit of surviving, which is more than one can say for some individual companies or certain bonds.

Timing, of course, is always debatable, even with broad asset classes, which is an argument for maintaining some mix of the world's capital and commodity markets through thick and thin. The question, as always, is how to structure the mix and manage the betas through time?

As it happens, that's the focus of a new monthly newsletter (The Beta Investment Report) that your editor will launch later this month (details to follow on CapitalSpectator.com). For the moment, though, we're simply gazing backward, in search of some basic perspective. Knowing where you've been and what history looks like is the foundation for looking into the future and assessing risk as well as opportunity. As always, a surplus of both awaits. The critical challenge is fleshing out the details, which is the mandate of our soon-to-be-launched newsletter.

This post can also be viewed on capitalspectator.com.

Corn Prices Surpass $6 A Bushel: Investors, Grab Your Overalls

Corn prices have jumped dramatically during the past few months, hitting a record high of more than $6 a bushel. Demand for corn has increased, and the outlook concerning whether future supply can meet this demand is uncertain. This news is great for agricultural farmers, at least agricultural farmers, but it will have several negative repercussions for just about everyone else. Corn and corn-based additives—such as corn starch and corn syrup—are used in many foods and in animal feed for pigs and cattle. An increase in corn prices is one of the driving forces behind the price increases of numerous other foods.

The use of corn in ethanol production is also driving up the price of corn. The government recently passed legislation calling for more ethanol production, which could result in even higher corn prices. I wrote about the validity of ethanol as a long-term alternative fuel source in a previous post, and you may want to read it for more insight.

The harsh weather in the Corn Belt region is also having an impact on corn prices, but this phenomenon may only affect this year’s crop. A bigger issue could be the amount of land being dedicated to corn production. This year there is expected to be around an 8 percent drop in the amount of farmland planted for corn according to a recent AP article. You may recall that last year, farmers increased the amount of farmland planted for corn quite dramatically in response to the then-record $4 a bushel price. When time comes to plant crops for next year, we can probably expect to see a similar increase, which should eventually help regulate the price a bit.

One thing to keep in mind is that there is only so much farmland, and if farmers choose to plant corn on that land it means they are doing so at the expense of some other type of crop. The last time farmers went to corn en masse, wheat and soybeans saw tremendous gains--maybe this will be an area of opportunity for investors once again in the future.

Investors who want to investigate the potential opportunities available with farmland investment, and see how they might profit from the rise of corn prices, should read our article: Farmland Investment.