An Interview with Victor Adair

Victor Adair has been trading commodities for 35 years and has held several senior jobs in the brokerage community. He is now senior vice president and derivatives portfolio manager for MF Global Canada Co., a unit of MF Global Ltd., the leading broker of exchange-listed futures and options in the world. He currently trades on behalf of a group of high net worth individuals and corporations. He's also a market analyst and frequent speaker at investment conferences throughout North America.

Adair recently spoke with HardAssetsInvestor.com, not only about where commodity markets may be heading, but his approach to investing, which has enabled him to outlast many of his peers.

HardAssetsInvestor.com [HAI]: Commodities in general have been in a tremendous bull run. Do you see this coming to an end soon?

Victor Adair [Adair]: We have seen an enormous flood of money come into the commodity sector in various guises over the past five years, and that money is from people who have never been in the commodity sector before. Any time hot money rushes into a sector, there has to be some plausibility for them to be there. And clearly they bought into the belief that emerging markets were going to introduce an element of demand in the commodities that wasn't there before.

We have to ask ourselves, by how much have commodities been goosed higher by the speculative money than they otherwise would have been? I am, as a cynical optimist, expecting at some point those newly arrived folks are going to get their feet held to the fire. To some degree we've seen that already in gold.

Where it will get interesting is if it's perceived that not only the American economy, but the European economy and maybe some others, are softening so that demand will not be there. I'm not one who believes in de-coupling. I think that if the American and European economies go soft, the Asian economies will go soft too and that will be a test for commodities.

HAI: Do you think commodity markets are discounting the possibility of a serious U.S. recession?

Adair: The commodity rally here in the face of the obvious slowdown in the American economy is a bit like Wile E. Coyote running off the edge of the cliff but he doesn't realize it yet. I'm not short, because as a seasoned trader, I may anticipate that the commodity market is going to have a break in price because of diminished demand, but just because I think it ought to doesn't mean it will. As a risk manager, managing risk for me is far more important than any ideas I might have over how things ought to be. I will wait until I see a confirmation that my idea is right before I assume a position.

I think it's more likely we'll see some kind of correction in this commodity run than we will see it march steadily on to the moon.

HAI: And what do you think the trigger might be for that? Are there any warning signs to watch out for?

Adair: It'll be a perception that we're not having a recovery in the American economy; that is, if it's perceived that the actions of the Fed so far, and the fiscal activities from the government, are not causing the American economy to turn around and improve - and also if we get the notion that the European economy is weak.

HAI: What commodities seem to be the most overvalued at this stage and seem to be the most vulnerable to a pullback?

Adair: Probably the energy sector. And it might be relative. One of the ways I think is in terms of spread. I track the gold-crude oil ratio. We're within a hair of 50-year lows on that spread. It's seven and a quarter barrels of crude to buy one ounce of gold. As recently as the beginning of last year, it took 12 barrels of crude to buy an ounce of gold. Back in 1998, it took 27 barrels of crude to buy one ounce of gold.

To say it one way, gold is real cheap in terms of crude. That doesn't mean anything necessarily, but that's something I watch. Usually when you ask the question of what commodity is overvalued, we're thinking in terms of dollars. Crude oil is at $120 or more; it's an all-time high. But I'm really interested in relative values.

HAI: What about investing in stocks of companies involved in commodities? Are there some interesting opportunities there?

Adair: I like the commodities market because it's a pure-play. If you're bullish on gold, buy gold; don't buy shares in a gold mining company.

A great example is two years ago, people were horny about uranium, so they bought [Canadian uranium producer] Cameco. But one of their mines sprung a leak and the stock price plummeted, while the price of uranium went up. Cameco may be a wonderful company, with great people, but it's not the same as buying uranium. So just be clear on what you're buying.

One of the things I watch is the share price of Potash [Corp. of Saskatchewan]. I use the share price of potash as a psychological thermometer for the public participation of the commodity markets.

HAI: And that's a stock that has tripled in a year. But putting aside the risks of the recent rush of money that's come into commodity markets, what do you think about the long term?

Adair: Optimistically, the world continues to be a better and better place. It's actually a more peaceful place than it probably has been in our lifetime, even though we have the threat of terrorism hanging over us. There's probably more people getting a decent meal than ever before in history.

The Americans wash their laundry in public and there's no better economy at being able to create a destruction mode, deal with a disaster, get over it and move on in a better way. So I'm very optimistic the longer-term trend for commodities seems rosy, just because there's a lot of people around the world that are going to want to eat better and drive cars instead of bicycles and so on.

HAI: So you don't see Asian demand tapering off?

Adair: Sure I do. I think it's very possible that this commodity bull market we've been on for a few years now could have a correction. And if we have a slowdown in Western economies, that will likely slow down other economies. I don't think you can expect that Chinese internal demand is going to totally replace their export sales.

The markets in my mind are driven more by psychology than real changes in supply and demand. So if the market senses there's a potential slowdown to come, that would start the correction. But longer term, I think you can build a case for stronger, persistent global demand for real things. There's going to be demand for steel, there's going to be demand for cement, there's going to be demand for soybeans.

This all reminds me of Japan in the very late 1980s. In the fall of 1989, I'm in Chicago. I'm about to get on a plane to fly back to Vancouver. I pass by a bookstore and in the business section, virtually every book is about how to get rich like the Japanese or how to use the Japanese method to run your company or something. At that time, nine of the top 10 banks by capitalization were Japanese. Now none of them are. Japan was going to run the world, as far as the popular press was concerned in late 1989, and of course the Nikkei topped out in December, and within nine months, fell in half.

At this point it seems as though China is going to run the world. And the cynic in me says, yeah, well, we'll see. If we look over our shoulder at what has happened and see how much things have changed, how could we possibly anticipate that the future won't be full of changes. And that's what as a trader you try to do. I describe my job as trying to imagine the world in the future, different as it is now.

HAI: Is that how you've been able to stay in this business for so long?

Adair: I will tell you for sure, for me, making money as a trader is far more a function of how I manage the risks of my trade than having a good crystal ball. I will always have a point where I know I'm going to get out of a trade if it goes against me before I get in.

For instance, if I'm going to buy gold at $880, and it gets down to $860, I say, you know, I'm wrong on this, I'm out. So I'm going to lose a couple of bucks, but I kept my sanity and the bulk of my bank account, so I can go back in and find another position to put on.

In my career as a commodity broker, I've watched hundreds and hundreds of people lose millions and millions and millions of dollars. And there are a couple things that they do that I don't do anymore. The public, typically the retail commodity speculator, uses far too much leverage. Then the classic is, they'll go into denial when they're wrong.

I'm serious when I say making money is a matter of managing risk rather than having the best crystal ball around. Every once in a while you may have a hot hand or a few consecutive trades that work, but I never, I hope, get arrogant enough that I can predict the future. If I meet somebody in these markets who's arrogant, I automatically assume he's ignorant. You've got to be humble.