What Makes Real Wealth?

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 |  Includes: CEO, GDX, GOLD, OXY, SCCO
by: Dr. Stephen Leeb

This year the Nobel Prize in Physics went to two scientists at the University of Manchester who discovered the properties of graphene. And yes, this event is significant for investors, because it reaffirms what constitutes real value in today's world.

Graphene, as few people know, is a transparent form of carbon that is only one atom thick yet stronger than steel. It has the potential to be made into a new generation of faster transistors, better touch screens, solar panels, windmills, and other technologies. Of course, it will take time to develop graphene applications, but the results could be very exciting.

The amazing thing about the discovery of graphene's properties is that it didn't result from computerized number crunching – which most research focuses on today – but from the intuition, creativity, and spirit of playfulness on the part of the two scientists involved. Apparently, they were horsing around in the lab one Friday night (what else would scientists do at that time?) when they figured out a way to extract graphene from the graphite in a pencil and arrange it in a 2-dimensional array using a “Scotch tape” technique. The result let them test the properties of this substance for the first time.

We should also note that one of the scientists, Andre Geim, has a history of wacky and creative work. He also invented an adhesive called Gecko tape (that imitates how lizards stick to walls) and received an Ig Nobel Prize for levitating a frog in a magnetic field. (Ig Nobel Prizes are given to findings that make people first laugh and then think.) His work, in other words, is a testament to the value of human creativity.

In contrast, an item we watched on 60 Minutes last night shows the lack of value produced by our modern reliance on information technology.

The item was about high-frequency trading strategies (HFTS). These are computerized trading activities that many feel were the cause of the Dow's 1,000 point, 10-minute plunge in May. Most amazing (or horrifying), HFTS now accounts for 60-70% of all trading on the New York Stock Exchange.

At the risk of oversimplifying these very complex programs, HFTS take advantage of price differences that exist on the market for tiny fractions of a second. The programs rely on very complex algorithms to find opportunities. By buying and selling high volumes of shares rapidly, the computers generate profits for their operators.

What bothers us is that HFTS violate the essential function of the stock market, which is to reward good companies by providing them with the money they need to expand, while rewarding the investors who bankroll good companies. In addition to rewarding the talented, the system makes for a stronger economy and society.

The problem with HFTS is that they create no real wealth. They merely reward people for cheating the system, without creating jobs or providing any benefit to the world.

Worse, we think HFTS harm society as a whole. They take money away from enterprises and individuals who would benefit the world – such as innovative scientists - and from investors. They discourage the public from buying stocks, since average investors know they cannot compete against HFTS. The more the market appears rigged, the more legitimate money migrates to the sidelines, and the harder it is for good businesses to raise capital.

Sure, investors can still earn profits over the long haul, but it galls us that those long-term rewards are lessened by HFTS that continuously drain money out of the market.

Jim Gray, in his book The Fourth Paradigm, argues that scientific breakthroughs from now on will result from using powerful computers to analyze massive databases. That sounds like good news to the less creative and intelligent scientists – they can sit back and let the computer do all the work. Unfortunately, IT (information technology) is no substitute for HC (human creativity).

As we pointed out last week, IT (the kind that's behind HFTS) has reached the point where it's creating more problems than it's solving. Investors therefore need to look harder for legitimate sources of wealth. And that brings us, once again, to commodities.

IT will not solve the world's growing scarcity of copper, oil, or tin. Nor will it solve the logjam in iron ore supplies. (Iron ore has been one of the best performing metals in the past 12 months. That’s because even though there's plenty of it around, the cost of shipping it to where it’s needed has driven the price higher.)

Resource scarcity is the biggest threat human civilization has faced in centuries. And if all we can do with IT is block needed solutions (using HFTS) – sacrificing long-term benefit to the world so that a few individuals can make short-term gains - then IT is no longer our friend. Instead, we need better ways to provide incentives to creative, intelligent scientists - like the Nobel Prize Winners we mentioned earlier. Most great discoveries don't come from computers but from creative minds tinkering around in labs or with chalk on blackboards. They come from human imagination.

Last week, I was privileged to give the keynote address at an energy conference sponsored by J.P. Morgan. I spoke alongside a Nobel Prize Winner, and the audience was very sophisticated. However, when I asked how many people thought copper was a scarce metal, no one raised their hand. A few had heard of rare earths, but who hasn't since they've been in the news recently? The event showed me how most people are far too focused on information technology to have spotted the real problems facing the world this century.

Fortunately, that can't be said about you. We will continue to steer you towards investments in areas that offer the highest long-term potential for profits, chief among those being commodities.

As you know, we recommend Southern Copper (NYSE:SCCO) as an excellent way to profit from the very real and growing copper scarcity. We also recommend well-positioned gold miners such as Randgold (NASDAQ:GOLD) or the Market Vectors Gold Miners ETF (NYSEARCA:GDX). You should also invest in some of the few oil companies that can increase their production and reserves, including CNOOC (NYSE:CEO) or Occidental Petroleum (NYSE:OXY). Many of these are trading near all-time highs, even though oil prices have yet to fully recover. When oil makes its next move into triple-digits, stocks like these will likely produce very high returns.

Disclosure: Leeb Group, its officers, directors, shareholders, employees