By Sumit Roy
AIS Group’s CIO lays out his bull case for commodities across the board.
John Hummelis president and chief investment officer of Connecticut-based AIS Group. He has 40 years of experience in portfolio management. Hummel has managed assets for Fortune 500 retirement plans, endowments, foundations and the Federal Reserve retirement plan, as well as high-net-worth individuals. He manages $400 million, primarily in the firm's long-only Tactical Asset Allocation Portfolio strategy and managed futures-style Managed Asset Allocation Program strategy, and just released the company's first mutual fund, AIS Tactical Asset Allocation (MUTF:TAPAX). HAI’s Sumit Roy recently caught up with Hummel to discuss his views on the commodity markets.
HardAssetsInvestor: What stage of the commodity bull market do you see us in, and what do you think will drive commodities going forward?
John Hummel: The Nasdaq bull market of the 1980s and ’90s is a good comparable reference. In that bull market, you had an orderly advance up through 1987 in the stock market; you had the very sharp sell-off in ’87; you had a two-year recovery; you had another milder bear market; and then between ’91-’92, you embarked on an accelerated phase.
I believe what we experienced in the commodity markets in 2008 is roughly comparable to the 1987 break in the Nasdaq, and the most recent correction from the third quarter of 2011 through May of last year would be comparable to the 1990 area of the stock market. In my view, we are about to embark on a second, multiyear advance that’s going to be more powerful than what we saw from 2001 to 2008.
HAI: Interesting. And are the drivers of this next bull market phase the same as we saw in the first half of the bull market; namely, China and all those emerging markets?
Hummel: Yes. There is an unprecedented expansion of entrepreneurism and expansion of the middle class in the developing world. The world has never really experienced such a massive expansion like this. If you go back and look at Japan after World War II — or later on in Korea, Singapore, Taiwan — you can see the kind of dynamic growth that you can have for two decades or more.
The only difference this time is that you’ve got these huge population masses in China, India and Brazil — throughout Latin America, Eastern Europe and even Russia. It’s a very powerful force. China’s middle class, as a percent of the total population, will triple this decade versus last decade. Other countries — like India — are further behind, but they're going through the same thing.
They’re at a stage of their economic development that’s very commodity-intensive. The middle class wants the things that we in the West have experienced for decades. They want to eat more meat in their diet; that puts more pressure on grain prices. They want the electronics, the motorcycles and the cars. And then there’s the urbanization that’s taking place in all these countries, which puts huge pressure on infrastructure development. That leads to huge demand for industrial metals and things like that.
Hummel: And then, at the same time, from a supply standpoint, the financial problems that we had in 2008 — and then the financial crisis in Europe last year — has done a lot of damage in terms of delaying development of new projects. It’s generally made businesses skittish in terms of investing in expansion. If I'm correct that we’re entering another demand growth phase, the supply shortages are going to develop much more quickly than they would have if we had had uninterrupted growth over the last four years.
In particular, conventional oil supplies are going to be a chronic problem. Conventional oil, which really drives transportation, has had minimal growth from 2005 through 2011. At the same time, the consumption within the major exporting countries has been accelerating faster than any production increases that they might have experienced. The amount of oil that’s actually been available for export has been declining.
At the same time, you have this growing demand out of China and India and, as well as the Middle East. The only thing that’s really kept oil prices from exploding to the upside is the tepid economic conditions in the developed world. Oil is going to be a chronic problem going forward.
HAI: So I presume you think that the recent boom in the U.S. oil production is just a blip on the bigger picture?
Hummel: Yes. My hat’s off to American technology, but the hype that’s come out in the last couple of months is a real overshoot. People don’t want to look at the facts. First of all, the fracturing of tight oil formations has been around for 60 years; it’s not a new event. The only thing that’s really made it possible is higher prices. It’s economic to do it now. But unlike conventional oil, the flow rates are much lower. And once the well is completed, there’s usually as much as or more than 80 percent decline in the production rate over the first two years. You drill a lot of wells, but you get very little production for years. You don’t get the oil out like you would out of a conventional field.
Hummel: How are the other energy sectors performing: natural gas, coal and nuclear? They all seem to be out of favor right now. But are you seeing investment opportunities there?
Hummel: I am. Coal demand continues to be strong in the developing world. In the United States, the EPA and the current administration have been very unfriendly to coal. That, combined with the low price of natural gas, has caused a real switchover to gas in this country. But you're also seeing a decline in the number of new natural gas wells that are being drilled. Because of that, you're going to see natural gas production start to fall off and you're going to see prices take off.
Additionally, nuclear is something that’s absolutely necessary. Germany, which was going to get rid of all their nuclear plants, is now reconsidering. Japan, with the new administration, is reconsidering nuclear power. China, India and a lot of other countries are building nuclear plants. Thus, I think that uranium is going to be a good investment.
At some point out there, you're going to have a shortage of uranium for the number of plants that are being built.
HAI: Shifting gears a bit, why hasn’t gold responded more positively to the recent monetary easing by the Fed?
Hummel: That’s a good question. Gold, in the last 12 years of its bull market, has had a number of times where it’s gone into very long trading ranges that have lasted more than a year. We appear to be in another one. But our work still suggests that it’s in a long-term bull market and that it will emerge out of this trading range to the upside.
There has been some loss of demand in India because of the weakness of the Indian rupee, which will make gold more expensive in the currency. There also was selling late last year as people took profits to realize gains and pay taxes at the lower rate. Still, we don’t believe the bull market is over yet.
HAI: What segment in the commodity markets are you most bullish on?
Hummel: That’s always also a difficult question. I believe that U.S. energy prices are embarking on another advance. I see, in the next several years, the gap between WTI and Brent closing.
I also see grains in a long-term bull market. There's a lot more upside there. The metals — both the industrial and the precious metals — look attractive as well. I see opportunities across the board.
HAI: For your funds, do you prefer exposure to the stocks of the commodity producers or the actual commodities, such as GLD and the like? Or does it vary from commodity to commodity?
Hummel: It varies from strategy to strategy. We have four different strategies. We have a diversified futures fund that only trades futures contracts. That trades the metals, the grains, the energy, currencies, fixed income and equity indexes. And it can be long or short.
We have a tactical asset allocation strategy that is very conservative. It’s designed to compete against balanced portfolios. That’s a long-only strategy with no leverage. We buy individual stocks; we can buy long-term Treasury bonds; and we can buy gold or GLD. We can actually buy gold bars there or GLD, depending upon the size of the account.
We have a gold fund that trades gold and silver futures, as well as invests in individual mining companies. Finally, we have a small equity-hedge fund that buys individual companies. There we would invest in things like energy service companies. And we can use stock index futures to hedge against the market if we feel it's appropriate.