Commodities for Income Investors

1. Introduction

What does the past week’s market activity tell the high dividend income investor who is considering taking new long positions to get some return on cash that’s lying fallow? What follows is nothing fancy, people. Just a simple follow up and update to last week’s post Notes on a Scandal: High Dividend Investor's Survival Guide to This Unsustainable Rally, and some practical tips on what to do now.

Caveat: I’m not a prophet. The following conclusions are just based on the evidence I present below that this is not the time for new long positions. I’m still innocently (naively?) assuming we have a free, open and transparent market operating. However, given the degree of market manipulation we’ve seen (see Notes on a Scandal: High Dividend Investor's Survival Guide to This Unsustainable Rally) and mentioned in recent posts, one could argue otherwise and try to bet on a continuing rally aided and abetted, legally or not, by team Washington & Wall Street.

2. What The Charts Suggest

A. Chart 1

Overall market broke its long term downtrend at the end of March, and the rally has stalled out in early May.

B. Chart 2

For the past 6 months the market has traded in a range between 680 and 940.

C. Chart 3

Since the rally stalled in early May, volume on down days is greater than that on up days, and there have been about 3 times more down days than up days. This suggests lack of conviction by market participants.

3. Conclusions

A. Be Cautious Taking New Long Positions

From a very simple technical perspective, the current rally has stalled. From a fundamental perspective, as noted in Notes on a Scandal: High Dividend Investor's Survival Guide to This Unsustainable Rally, the rally is mostly unjustifiable, and arguably the result of outright manipulation by Washington and Wall Street. Perhaps this is for the greater good. It has allowed at least some of the major banks a rising market into which they can sell stock and raise needed capital from willing investors, not just captive taxpayers. For example, both Goldman Sacks and Bank of America have done so thus far.

B. What This means for Dividend Income Investors

Yes, it hurts to sit with cash producing no income. Because both fundamental and technical evidence suggests it’s more likely that stock prices in the coming months will fall, recent advice still holds. Take only partial positions using cash that will not be needed within the foreseeable future. Consider taking at least partial profits or losses if you foresee needing to raise cash in the coming months from your stock portfolio. Consider hedging techniques discussed in prior articles.

For example, for short term hedges consider: UltraShort S & P 500 Proshares (SDS), UltraShort Financials ProShares (SKF), UltraShort QQQ ProShares (QID), UltraShort Real Estate ProShares (SRS), UltraShort Russell2000 ProShares (TWM).

For those who can, consider owning Canadian or Australian dollars, or assets based in these currencies. Why? To alter the famous line about plastics from the film, The Graduate, “commodities, Benjamin, commodities.”

C. The Real Meaning of What Jim Rogers Has Been Saying

This past week renowned investor Jim Rogers was widely reported to predict a coming crisis in the currency markets as governments worldwide attempt to bolster their economies by expanding the supply of their currencies, thus ultimately eroding their purchasing power once the world economic situation improves and demand for goods rises.

Even for those well versed in currency trading, that advice is not easy to put into practical use. If all currencies are inflating, and currencies always trade relative to one another, so how does one know which currency to prefer over another?

One could consider which currency is being most burdened with debt and thus likely expansion of supply, as suggested by the following IMF (International Monetary Fund) chart provided by Kathy Lien in Will the U.S. Be Next to Receive a Credit Warning?

That might work if you want to trade currencies AND the rest of the market follows the same chart. Maybe it will work, maybe it won’t. Successful trading is not just about being right about the asset, but being right about what the rest of the market will think about it, and when.

Here’s a simpler idea. While choosing the right currency pair may be unclear from Rogers’ remarks, what IS clear is this: commodity prices should be in a long term uptrend, if for no other reason than their being priced in eroding currency, typically US dollars. So invest in instruments that will rise with commodity prices.

THAT is the obvious implication from Rogers (who has made a few bucks in commodities).

Thus consider, strongly, one or more of the following investing options:

· Commodities themselves via ETFs, CFDs, futures, etc. A very creative and worthwhile suggestion from a comment I received on an article, one which I recently followed – consider a investing in a hybrid car, better home insulation, or other energy saving devices. Yes, cars are depreciating assets, but if you have to commute long distances anyway, the savings could well be worthwhile. FYI I went for a Toyota (TM) Prius. It handles very well, has sufficient acceleration when needed, and cut my gas bill by more than half. My only complaint is the very primitive sound system, especially considering this is not a cheap car. It’s not strictly an income investment, but a penny saved IS a penny earned. No, it’s better. There is no tax on the penny saved (yet), at least until you invest it.

· Convert at least some US dollars to Canadian or Australian dollars (which rise relative to other currencies as commodity prices rise)

· Income instruments based on commodities that should rise with them. Many of the stocks I’ve been recommending fit that description, especially WHEN stock prices pull back. These include:

· Big Oils: BP, plc (BP), CNOOC Ltd. (CEO), Eni SpA (E), Total Fina Elf (TOT)

· Canadian Energy Trusts: ARC Energy Trust (OTC: AETUF, TSX: AET-UN), Claymore/SWM Canadian Energy Income Fund (ENY), Enerplus Resources Fund (ERF), Peyto Energy Trust (OTC: PEYUF, TSX: PEY.UN), Provident Energy Trust (PVX, TSX: PVE.UN), Vermillion Energy Trust (OTC: VETMF, TSX: VET.UN)

· Coal MLPs: Alliance Resource Partners (ARLP), Northern Resource Partners (NRP), Penn Virginia Resources Partners (PVR)

· Canadian Real Estate Trusts: While real estate is not a commodity, it is a hard asset that is inflation resistant. A worthy group of stocks to keep in mind when prices pull in include the Canadian Real Estate Trusts: Canadian Apartment Properties REIT (OTC: CDPYF, TSX: CAR.UN), Northern Property REIT (OTC: NPRUF, TSX: NPR.UN), RIOCAN REIT: (OTC: RIOCF, TSX: REI.UN

The Gabelli Global Gold, Natural Resources & Income Trust (GGN): a way to play gold and get income

However, again, be cautious about new stock purchases until we see a pullback. Why? Here’s a lesson worth repeating.

D. Even Great Stocks Usually Follow The Market

Remember, no matter how good their results, few stocks avoid selloffs when markets decline. So be cautious buying income stocks based in commodities or commodity based currencies at this time.

For example, look at a chart of Atlantic Power Corporation (OTC: ATPWF.PK, TSX: ATP.UN) compared to the S&P 500 (in red).

Note that ATPWF’s price movement followed that of the S&P 500 index. Despite producing stellar results during this period, including raising dividends while cutting debt and openly declaring the dividend secure for years to come; its price fluctuated in the same directions as the index.

Ironically, ATPWF’s price was actually more volatile (due to its low daily trading volume), despite its far healthier and more stable revenue stream than almost all companies in the index.

The lesson: You generally do not take long positions when the evidence suggests prices will drop. thus even though the recovery of energy prices and stocks seems inevitable, it’s not yet the time to buy. By all means place orders starting near the March lows, though.

4. Conclusion, Disclosure & More Info

Again, the Caveat: I’m not a prophet. The following conclusions are just based on the evidence I present below. I’m still innocently (naively?) assuming we have a free, open and transparent market operating. However, given the degree of market manipulation mentioned in recent posts, one could argue otherwise and try to bet on a continuing rally aided and abetted, legally or not, by team Washington & Wall Street.

Disclosure: I have positions in most of the above mentioned investments.

Comments

[RiskReturnO...:]

Good article.

I'm been following Jim Rogers advice, and have benefited from being long DBA all the way from the low 20's, even before the latest weak dollar fun. The long term fundamentals are great for the agriculture commodities as demand keeps rising in China and India; any weakness in dollar and associated re-flation trade will likely push DBA to the low 30's. Volume has been impressive for the past week, supporting the typical seasonal run-up during Winter months in Argentina and Australia. Look for quick filling of gap (post-Lehman hedge fund redemption) at $30, and if volume continues to run at 150% of average, then $33-$35 looks reasonable as medium term target.

May 29 11:32 AM

[Dividend Gr...:]

The S&P 500 is consolidating between 929 and 875. A decisive move above/below these levels would be bullish/bearish. I wouldn't call the rising move from 680 to 930 a "range" however.

May 29 01:48 PM

[bricki:]

I hope it isn't a range, but with the new dynamic of third world levels of volatility in first world equities it could be.

If it turns out to be so, I'm going to start re-purposing sick bags from bankrupt airlines to stock traders everywhere.

May 29 03:39 PM

[Kinabalu:]

"both fundamental and technical evidence suggests it’s more likely that stock prices in the coming months will fall"

I nominate Mr. Wachtel for a Nobel Prize in Economics for his Inefficient Market Hypothesis.

May 29 05:53 PM

[Mad Hedge F...:]

best for this crowd to buy a basket. If you have been aggressively long commodities of every size, shape, color, and flavor, as I have been all year (www.madhedgefundtrader...), then you just had one of the best trading months of your career. The CRB index rocketed by 17% in May, the best move since the early days of the first oil shock in 1974. That year I spent weekends driving my Volkswagen van from Los Angeles down to Mexico, where I filled it with jerry cans of gasoline, because it was still selling for 25 cents a gallon there (an early attempt at arbitrage). I finally sold the vehicle and used the cash to buy a one way ticket to Japan (remember that John E?). My favorites went up the most. Crude leapt 29%, Silver clocked in a 23% return, and gold was up 9%. The producing stocks also did spectacularly well. Coal producer Massey Energy (MEE) soared by 44%, dragged up by oil, while my beloved Freeport McMoran (FCX), with the world’s largest gold and silver reserves, rose by 30%. While these things are all superheated on a short term basis, the ten year agreements are still good. You can find massive Chinese buying behind almost every one of these.

May 29 09:44 PM

[svosavvy:]

Always interesting thanks,

As to your vehicle hedge, and real world arbitrage. Why not go for a 5 year old honda that you can get for peanuts and gets great mileage. You have to burn a lot of gas to make up the spread, also if you front cash for the older one you can forego collision coverage, invest the insurance savings, pending that you believe in yourself as a safe driver. I totally agree with the penny saved tax truism. I always like it when you talk up pvx. A most important point about the volume showing up on down days. Being relatively young, I am in long term love with some of my march buys and have such hedged to the down by selling leap calls in a gradient fashion as to not run out of options powder. If called away it will be to the sound of doubles and triples, but, if we get a robust downturn it will be an easy buy cover. In the near term time gets to eat away at their value. Land owners like myself are going to get hammered with our eroding tax base. I Continue to collect the loonie, and hold timber on the stump a commodity that always grows despite market conditions.

May 30 12:06 AM

[Maxe Paul:]

Why would you put in orders at the March low? Makes absolutely no sense whatsoever.

Im always amazed at how people on this site pump ETF's and CFD's, synthetic garbage etc, and "invest in a hybrid car" ? Thats hardly going to help with investing in commodities is it?

Yes all pile into the Aussie dollar at 80 plus cents so i can sell it when we inevitably go to 50 cents next year!

Glad im Australian, that's all i can say here.

May 30 04:04 AM

[Old Trader:]

I'd be somewhat cautious about getting into the CanRoys, only because of the upcoming changes in their structure (basically, they're being abolished). Having said that, I do own 2 (PVX and PWE), but both have been long term holdings in my core portfolio.

Regarding coal, there's no question that the current administration is NOT a fan of coal, so if one were looking at coal, a producer of met coal might be a better bet, assuming that at some point, steel production will turn around.

May 30 10:04 AM

[Charlie P:]

What are the tax consequences of owning Canadian stocks for the US investor? I ask because what you write regarding the ownership of Canadian based commoditie stocks is compelling

May 30 10:10 AM

[ed233:]

I like the basic premise of this article although I don't know if I would be going long in any position for the foreseeable future. Commodities are good investments when the economy is starting to ramp-up. My rationaI thinking says that long positions should be made when there is evidence of sustainable corporate earnings. I see little or no justification until economic conditions change for the positive. The economists are predicting a recovery in the last quarter of this year or no later than the first quarter than 2010. So far the evidence is pointing to a later prediction. That doesn't mean that one couldn't take positions when a correction appears. I agree with the author that the likely entry point would be around the March 9th lows as a guide line. The dollar is under pressure and this should last for some time until the Obama administration starts to rein in their absurd spending patterns and make it clear to the investor that they have a plan to exit from the private equity world. LOL Looking after your money.

May 30 10:27 AM

[April May:]

An unbelievable nightmare! I own several Canadian partnerships and a few in America. You will receive a K-1 instead of a 1099 from each of them at tax time, and quite late at that (end of March, early April). You'll need an accountant to report those figures properly on your income tax return (USA). I have prepared my own tax returns for over 40 years, and yet I was stumped when trying to decifer those energy K-1's. Even the IRS booklets didn't help me.

Is it worth the tax headaches in April? I'm not sure yet. If you usually use a CPA at tax time, then it shouldn't matter to you.

Why did I take a chance? High dividends lured me. But LP's dividends aren't really dividends in the eyes of the IRS--they are a distribution of the partnership's earnings and must be reported on a separate IRS form, and not with other "real" dividends. It is quite complicated. You also report other activities of the partnership such as depreciation.


On May 30 10:10 AM Charlie P wrote:

> What are the tax consequences of owning Canadian stocks for the US
> investor? I ask because what you write regarding the ownership of
> Canadian based commoditie stocks is compelling

May 30 12:28 PM

[La Marque:]

April May
My experience is the same as yours with only US MLPs. After 3 years of wasting a lot of time on tax forms, I sold out. I now own a couple of CEFs (TYG, FMO0 which are regular dividends because the fund pays the taxes on their MLP holdings. MLPs held in tax-free or tax-exempt accounts have a maximum $1000.00 annual limit on 'dividends'; above that one is subject to penalties.

Charlie P
Regular Canadian stocks are foreign stocks and have a standard 15% withholding of taxes. I have no knowledge of royalty trusts.

May 30 12:57 PM

[Scoups:]

Turbo Tax handles it seamlessly.


On May 30 12:28 PM April May wrote:

> An unbelievable nightmare! I own several Canadian partnerships and
> a few in America. You will receive a K-1 instead of a 1099 from each
> of them at tax time, and quite late at that (end of March, early
> April). You'll need an accountant to report those figures properly
> on your income tax return (seekingalpha.com/symbo...). I
> have prepared my own tax returns for over 40 years, and yet I was
> stumped when trying to decifer those energy K-1's. Even the IRS booklets
> didn't help me.
>
> Is it worth the tax headaches in April? I'm not sure yet. If you
> usually use a CPA at tax time, then it shouldn't matter to you.
>
>
> Why did I take a chance? High dividends lured me. But LP's dividends
> aren't really dividends in the eyes of the IRS--they are a distribution
> of the partnership's earnings and must be reported on a separate
> IRS form, and not with other "real" dividends. It is quite complicated.
> You also report other activities of the partnership such as depreciation.
>

May 30 01:16 PM

[Bruno Brasil:]

And what if part of the excess liquidity our friends at the fed have been creating is finding more of its way in the "financial economy" : US equities (hence the current rally with no palatable improvement in the economy), gold, emerging markets, commodities/commodity exporting currency (hence selling pressure on USD) than in the "real economy". The inflation signs the Fed is looking for are already there!!!

May 30 02:02 PM

[Crude Oil T...:]

While I exited PVX late with the collapse in crude, it has always been a great weak dollar play with a great dividend. Long term we need to be cautious with these Canadian Trusts funds as we have changes coming in 2011 from our friends with government Canada.

May 30 02:22 PM

[Old Trader:]

AprilMay,

You're confusing MLPs with CanRoys. The K-1 issue involves any MLP, regardless of whether its Canadian, US, or from Botswana. Canroys don't have the same issue, at this point in time, although as Crude Oil Trader pointed out above, because of a revision in Canadian tax laws, due in a couple of years, it IS possible that some of the current Canadian Royalty trusts may convert to a MLP structure. Others may just opt. to become "regular" corporations.

The Canadian income trusts are very similar to US REITs, in that in order to main trust status, they MUST pay the bulk of their income out to unitholders. There are no taxes paid at the trust level, only at the unit holder level. This accounts for the high yield they've typically paid. The downside (there IS no free lunch) is that, again, like a REIT, if they wish to expand, they either have to pile on debt, OR issue additional shares, causing dilution to existing shareholders. Currently, there's a 15% tax on US holders of units. Because of tax treaties between the US and Canada, a US holder can offset this against his US taxes, although this option is not available if the units are held within a tax-advantaged vehicle (IRA or 401k).

Naturally, tax laws/regs are always subject to change, so consult with your tax adviser.


On May 30 12:28 PM April May wrote:

> An unbelievable nightmare! I own several Canadian partnerships and
> a few in America. You will receive a K-1 instead of a 1099 from each
> of them at tax time, and quite late at that (end of March, early
> April). You'll need an accountant to report those figures properly
> on your income tax return (seekingalpha.com/symbo...). I
> have prepared my own tax returns for over 40 years, and yet I was
> stumped when trying to decifer those energy K-1's. Even the IRS booklets
> didn't help me.
>
> Is it worth the tax headaches in April? I'm not sure yet. If you
> usually use a CPA at tax time, then it shouldn't matter to you.
>
>
> Why did I take a chance? High dividends lured me. But LP's dividends
> aren't really dividends in the eyes of the IRS--they are a distribution
> of the partnership's earnings and must be reported on a separate
> IRS form, and not with other "real" dividends. It is quite complicated.
> You also report other activities of the partnership such as depreciation.
>

May 30 04:49 PM

[Old Trader:]

The 15% tax is on unit distributions which are usually, but not always, paid monthly. Forgot to clarify that in my comment above.

May 30 04:51 PM

[sixpackistan:]

Fantastic article.

May 30 05:03 PM

[dsrtwriter:]

Very good article. Instead of a Prius, I get more comfort and physical protection (ie German steel) in my 1979 Mercedes 240 diesel stick shift, which costs me almost nothing to maintain.

And it actually looks nicer in style, even after all these years.

May 30 09:08 PM

[msgtb:]

Excellent post as always. Holding Canadian dollars invested in the Canadian stock market in some of the Trusts you suggested. I also hold FXA and some put options on UUP. Keep up your excellent posting you are one of the best I have seen.

Good luck and good trading

Thanks

Dave

May 31 12:50 AM

[Peter Cooper:]

You should also be considering silver for its leverage against the rising price of gold. This is a great hedge against the US dollar, like having gold on steroids, see:
arabianmoney.net/2009/.../

May 31 02:30 AM

[untrusting ...:]

For those who have not seen it, this a very worthwhile free video series on the economy, oil, debt, etc:

www.chrismartenson.com...

May 31 03:18 AM

[JCCIII:]

RE the discussion about K-1's and MLPs. I agree with Scoups; TurboTax Premier handles the K-1's seamlessly. Not discussed, however, is figuring your new cost basis each year. Being new to the MLP world, I have not figured that out. Anyone willing to share insight or experience in figuring out the annual new cost basis for their MLP holdings? Thanks.

May 31 09:38 AM

[Farmland In...:]

Jim Rogers is on the advisory board of a direct farmland investment partnership in Canada - Agcapita. Farmland investments have a high positive correlation to inflation - farmland is often described as "gold with yield". According to Agcapita Partners data, during the 1970's farmland in western Canada went up over 500% in nominal terms.

May 31 11:25 AM

[TradingHelp...:]

S&P 500 going to 990, may surpass 1,000. Volatility to decrease further too through the summer season. "For some weeks now we this weekly review has 'called' Q1 or Q2 2009 as the trough of the economic cycle. Initially there was much risk in the statement as the global and US recovery was by no means certain, but as the weeks have progressed the ongoing stream of economic data has increasingly supported this view. The consensus among market commentators has also moved towards our more optimistic pro-recovery stance and now a Q3/Q4 recovery is a mainstream prediction, rather than the hopeful rhetoric of the enlightened minority." seekingalpha.com/insta...

May 31 01:49 PM

[Dean M:]

Alot of smart people have taken both sides of the argument. Bottom line, they're all guessing and if anyone gets it right they were just lucky. Also it seems like your remark about how you assume free and open markets is like making excuses in advance, of course everyone knows we don't.

"Caveat: I’m not a prophet. The following conclusions are just based on the evidence I present below that this is not the time for new long positions. I’m still innocently (naively?) assuming we have a free, open and transparent market operating."

May 31 04:45 PM

[svosavvy:]

I would argue that anything that isn't a dollar is a hedge against inflation as long as you don't overpay. So get out there and spend, wow, I guess the stimulus really will work, it's almost like being held at gunpoint. I was cautious for months about further deflationary risk, I feel since the stress tests passed with no time bombs I am ready to look at deflation in the rearview mirror. I agree that the stress tests weren't hard enough, I haven't seen that many passing grades since basketry class. Well, if it helps people sleep at night.

May 31 10:01 PM

[Ames Tiedeman:]

PVX, PGH, and PWE should be looked at with strong consideration. These issues have doubled since the March lows but as Oil moves back to 75 one can expect dividends to be increased after watching them fall the past 6 months. A rising Canadian Dollar will help to boost your dividend return as well.

Jun 06 02:56 PM

[31October:]

I also had some MLPs, and the tax nightmare went on for a year after I got out. I made a great return buying and selling with the spot demand plus getting dividends, but that made following partnership basis even worse! Unless your sibling is willing to do your taxes for free, you will spend a *shocking* amount of effort on MLP taxes. And the IRS will dig them up every year, because none of the agents can figure them out either! The money was great, but they are a terrible hassle.


On May 30 12:28 PM April May wrote:

> An unbelievable nightmare! I own several Canadian partnerships and
> a few in America. You will receive a K-1 instead of a 1099 from each
> of them at tax time, and quite late at that (end of March, early
> April). You'll need an accountant to report those figures properly
> on your income tax return (seekingalpha.com/symbo...). I
> have prepared my own tax returns for over 40 years, and yet I was
> stumped when trying to decifer those energy K-1's. Even the IRS booklets
> didn't help me.
>
> Is it worth the tax headaches in April? I'm not sure yet. If you
> usually use a CPA at tax time, then it shouldn't matter to you.
>
>
> Why did I take a chance? High dividends lured me. But LP's dividends
> aren't really dividends in the eyes of the IRS--they are a distribution
> of the partnership's earnings and must be reported on a separate
> IRS form, and not with other "real" dividends. It is quite complicated.
> You also report other activities of the partnership such as depreciation.
>

Jun 16 03:46 PM