Commodities: Is It All Over?

Has the entire commodities theme broken down by the side of the road like an old car driving up a mountain in the summer? You know, 'cause it overheated? If you read enough articles or watch enough stock market television you will probably be able to come up with an explanation that makes sense to you (regardless of whether it is correct or not), but maybe there is no real reason other than one-way trades reverse course eventually, regardless of the fundies or anything else.

I have been a believer in commodity exposure since before I started my blog (back then there were far fewer choices), but I always repeat my belief in having moderate exposure. My thoughts about my commodity exposure is not that I am "going long commodities," but that I am adding in a little zig to my stock market zag (to be clear, I do have long exposure - I just don't view it as a "bet on commodities").

There is plenty of research that compellingly argues for 20%, give or take, in commodities and some readers subscribe to that line of thinking, but I have never been comfortable with a number anywhere close to that.

In buying gold, I hope I am buying a little something what will go up if there is an external event that crushes the market so in a way the price does not matter. No matter where gold is today or where it was yesterday if there is a terror attack tomorrow, I think gold would go up.

Another aspect about small commodity exposure versus large is how levered you are to one theme. If you were 20% yesterday you really need to decide what you think the Wednesday selloff means and whether or not you need to do anything about it. With a 3 or 4 or 5% weighting the consequences for being wrong are much less which makes managing a portfolio much easier.

As this has played out over the last few months I have not sold any GLD. A couple of my clients have DBA and I sold 1/3 of that in late Febrary, right around $40 (I think I disclosed that in the comments of a post but am not sure), and I have also disclosed selling some Vale (RIO) at around $35 and then later at $30.

The sales were not about trying to make big changes or time anything, but one sort of exit strategy is partial sales after a huge run. There is no right or wrong with this - if something grows faster than the portfolio there is logic in reducing, and if something gets too frothy there is logic in reducing (or maybe selling out).

Related: Commodities Experiencing a Record Sell-Off

Comments

[bluesmoke]

It's been a great learning experience. When mutual funds were the only game in town, commodities were out of reach. ETF's have changed all that. I plan to keep my diversified allocation around 10%. As someone said, all it takes is a prolonged drought in the midwest, a terror attack, or a financial meltdown for the market to shift...

[phdinsuntanning]

I hope bluesmoke is not planning any of his requierements for a recovery of commodities. IMO the key factor here is the rate of economic growth in China, if they succeed cooling to 7,5% a year and/or the FED stops subsidizing the financial mistakers, we will not need to jump to this roller coaster again - but dont take both facts for granted: I liked Roger criteria for gold allocation, just a little, just in case...but yield is yield and as the former city Prince said, the music is playing and we go dancing: 80% euros @ 4%, 10% aussies with good interest and 10% greenbacks, I dont know why, you tell me!

[valueguy123]

There were two clear signs that a bubble was forming. The first which was more recent was when there was such as demand for the DBA that it was forced to buy alternative futures. There was an article written March 4th on here about that. This just shows that unexperienced investors are piling in. Second, people were talking about commodities as a safe haven and basically making it sound like commodities could never go down and they would be as good a long term investment as blue chip stocks. Commodities are speculative at best and a lot of fast money has gotten into them and now they are all coming out at the same time and you are seeing the result.

[Lisa]

Roger, you seem to be saying:

1. Exposure to commodities is simply a function of asset allocation for you.

2. Price or valuation plays no role.

3. When the price rises sufficiently, you reduce your exposure (perhaps due to asset allocation).

But how then do you initiate positions? What stops you initiating an asset allocation in a vastly overpriced asset class?

[miner]

Commodities might have been overbought in the short term. But if one takes the longer view, I can not reach any other conclusion than that commodities are in the 2nd inning of a spectaculair bull market.
My reasoning, I believe, is simple common sense:
200 million new entrants in the middle class in China and a similar number of Indians want to eat better and want all the metal consuming things that the Western world takes for granted.
Nothing new at all, but it can't be repeated often enough.

[Bhakta]

I agree with Miner... There is a lot of profit taking at the end of the quarter to cover a lot of losses. The commodities are not dying. Demand in China, India, Brazil, Russia, Vietnam, Thailand, etc. is not slowing, it is growing rapidly and there is an ocean of cash in these places.

[Roger Nusbaum]

Lisa, when i implement a new client i try to avoid buying GLD after a big spike up. We implemented a bunch of people in early January, at that point GLD had been in a more moderate uptrend than what has gone on more recently. Up trends don't usually dissuade me but big spikes do.

Here's an example. I bought MON for most clients in Oct. It went up a lot and I sold some at around $122. The people that I bought GLD for in Jan, I just bought MON for today in the $96s so there I waited for some pull back. This entry point may be good or it may stink but i waited a while and it came back to me some.

Part of this process it technical, part is my perception of market sentiment. I've been in the business one way or another since 1984 so my expeerience in terms of what i have obverved gives me some confidence about this sort of thing. Obviously I get plenty wrong but the point is sometime sentiment matters a lot and sometimes it doesn't, likewise technicals.

[valueguy123]

I think people often say things like, "we are in a long term commodities bull market" or a "long term global infrastructure story" and they make the fatal mistake of ignoring valuation. They also seem to ignore the inevitable cyclicality of both. I have certainly employed the buy and hold strategy over the years to a select group of stocks in my personal account. For instance, I have owned some stocks in my personal account for over 10 years and the growth and compounded return on these names has been tremendous. However, I think that what investors don't realize about commodity and infrastructure names is that often times these stocks get well ahead of themseleves and are already pricing in growth for years to come. For instance, yesterday I bought CBI. I think it has tremendous long term value here in the mid 30's. However, I would have never bought it when it was in the 50's and 60's because to me at those prices the stock is already giving the company credit for the great growth you are seeing. I think that especially with commodities you need to be disciplined because these things often gain a lot of momentum quickly and can lose it just as fast. That is why a buy and hold strategy with a commodity fund like the DBA makes no sense. The DBA is not something similar to Berkshire Hathaway, Altria, or any other blue chip company you can name. There is just too much momentum in it by investors who don't understand commodities. So while the DBA may be worth $60 (just picking a price) in 5 years if you believe in a commodities super-cycle, unlike a blue chip stock I think you need to take profits when you have them and then rebuy on the inevitable dips.

[foreigner]

Gold miners, specially juniors were mostly down when the commodity was moving up. Maybe the roles are about to reverse!

[timski]

Canadian oil trusts pay you with distributions and capital gains on the way up, and distributions on the way down. I'm a firm believer in longer-term hydrocarbon energy trends, namely an absolute increase in global oil consumption even as some oil demand is destroyed by higher fuel costs or replaced by alternate fuels. Y

es, you can trim a little or add alittle depending on price movements, but why bother? If you're getting a high distribution yield, it doesn't matter about the stock price, provided that the trust is getting enough cash flow and income to sustain its growth and pay out its distributions in a consistent fashion. And, most of these trusts will be solid businesses after 2011, when the income trust structure is mandated to end.

[User 42142]

sure. sell the winners and keep the losers: cleverly balances the portfolio

[eric hart]

A few ideas to consider:
1) Most major industrial countries are growing their money supply at between 12-21% per year. This is not only a US dollar story.

2) Growth in money supply at a higher rate than productivity and economic growth is inflationary.

3) We are in a rising inflationary environment that is global in scale, and likely to continue for ten to fifteen years.

4) Commodities are a proven asset class in a rising inflationary environment. (but tend to do poorly in a stable or falling inflationary environment)

5) The average of assets allocated to commodities in major accounts of high net worth individuals (according to a recent survey) was 3%.

6) The asset allocation recommendation by a recent (2006) PIMCO study (analysis done by Ibbotson and Associates) recommends between 12-29% of assets in a portfolio should be allocated to commodities for minimizing risk, and maximizing return.

7) Assets allocated to commodities in portfolios invested globally are likely far from 12%, and much closer to 3%. Most people I talk to have 0% allocated to commodities.

8) The past is not the future. The future is not the past. We are over and through the tipping point and a tectonic change has occurred that has changed the economic landscape. People worldwide will be experiencing higher inflation going forward--and they will seek protection with commodities. 1980-2002 was a bad time to be a gold investor, in general due to stable or falling inflation. Going forward, its a different story for commodities.

9) The popular press has the story wrong--they report "the bursting of the commodity bubble", but completely ignore the change in economic fundamentals--which drive the investment returns. The story should be: "Correction in commodities presents investment opportunity"

10) Think for yourself.