Embrace the Commodity Rally Sooner Rather Than Later

by: Hedgephone

As a long-term deep value investor, I am usually a sanguine bull when it comes to stock market investing. Since the 1800's, it has always paid more to hold stocks than it has to hold cash under a mattress. Most of this outperformance, of course, comes from the specter of inflation and the fact that commodities like Gold do not payout a steady stream of cash flows in the form of dividend income from common stock investment along with innovation and the industrial revolution. There have, however, been several instances when holding Gold and commodities has outperformed equities over long periods of time.

In fact, it is well known that when commodities are rising and inflation is high, stocks tend to underperform. Once such instance is the 1970's. From 1972 to the peak in 1980 during the Iran Oil Embargo, the CRB rose some 270%. Meanwhile, the S&P 500 actually remained unchanged from the high of 1969 to the low of 1982. If that performance doesn't make you cringe, nothing will. Below is a long term chart of the CRB which shows the tremendous change in value over the seventies and today's fledgling rally.

So, what many are calling a "bubble" in commodities, is really just a reflection of the bailout and QE2 policies of "pushing on a string" and the Fed's misguided view of ex food and energy inflation measurement. By increasing the money supply beyond anyone's comprehension, the Fed is creating an environment where investors are "forced" to invest in fairly valued to overvalued equities, while the real beneficiary of these policies are commodities -- an area that most investors view as speculative given the herd like mindset of investors today. Many investors consistently use a rear view mirror perspective and pick the things that have "gone up" rather than things that will go up in the future. The vertical chart of money supply is not good for savers, business managers, or stocks of US companies over the long term, but is rather bullish for a continued CRB rally.

The long and short of it is that investors are going to have to embrace the commodity rally sooner rather than later. With the large drop from $450 to $289 currently in the CRB, investors should welcome the dip as a buying opportunity and pick up ETF's in Backwardization like SGG or funds that compensate for Contango like GCC. The increase in money supply beyond anyone's rational explanation is clearly driving the rise in the CRB and will continue to favor commodities over stocks for the foreseeable future. Commodity stocks, foreign stocks, and deep value equities with undervalued net cash or real estate, for example, should all do well in the new normal.

While many are fearing deflation and welcoming the Fed's constant intervention, the long term investor must focus on reality -- America has an aging population, huge fiscal deficits, an ever increasing supply of printed money, large persistent unemployment, and gigantic monopolies in nearly every industry stifling growth on main street.

If investors fear falling prices in goods and services, which may be warranted, shorting overvalued companies may be a good long term investment when combined with investments in foreign commodity producers, commodity etf's, and deep value equities. Stocks such as OPEN can be shorted against a 175 PE ratio and a 17X sales valuation. This company is poised to grow, but that growth is well priced into the name at current valuations. They have not invented the telephone, they have just found a neat gimmick (my opinion) to provide people with online restaurant reservations. While an interesting idea, the bottom line does not justify the valuation of $1.5 billion.

Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) are similarly overvalued with both stocks sporting PE ratios of over 63. Netflix is nearly saturated in U.S. markets and so is Amazon -- nearly 35% of Americans still lack internet access, let alone a credit card that they can actually pay off. If you feel that consumer spending is going to remain weak, shorting these types of stocks against your commodity portfolio could provide the peace of mind you need to stay long the space.

Disclosure: Long PALL, AGQ, GCC, RJI, RJA, DBA, GLD, SGG, Short AMZN, NFLX, OPEN