Investor in the Woods, Part I

Editor's Note: Rob Levin is a good reporter and a smart guy, but before he started writing for HAI, he knew very little about commodities. In fact, that's why we hired him.

One of the defining features of the current commodities boom is that it is bringing a wide array of investors into the commodities market for the first time.

Our challenge to Rob: Starting from square one, try to figure out if and why he (and others) might add commodities exposure to a portfolio ... and then report back to us.

What follows is the first installment of a regular feature, "Investor In The Woods," where Rob will explore the commodities market from a fresh perspective.

With stocks down and the dollar facing serious challenges abroad, a huge number of people are looking toward the commodities markets and wondering, "Is this the next great place to put my money?"

At least that's what the leader of a major financial planning firm told me recently.

"Commodity pressure and commodity questions and commodity business are at an unbelievable, all-time, high peak of interest," said Lawrence Passaretti, managing partner of Professional Planning Services, LLC, in Melville, N.Y., a group he formed two decades ago. "The problem is, most people don't understand ... how to [get into commodities] without taking unbelievable risk. When you look at it, it's probably the hardest area of the market to learn."

The fact that individuals are even considering investing in commodities in such large numbers is, in itself, remarkable. Never before in our history has the average man or woman been able to gain exposure to these markets as easily as they can now.

"It's a new ball game nowadays," said Brad Zigler, managing editor of HardAssetsInvestor.com. Zigler's been involved with this world for several decades, heading up marketing, research and education at the Pacific Exchange's option marketplace and Barclays Global Investors before becoming a financial research and communications consultant for a number of private and public organizations.

Easier Access

"You can get commodities exposure with a single share of one of the indexes or ETFs or ETNs right now, for twenty-five bucks or so," Zigler said. "You could not hope to do anything like that two decades ago [the last time the country witnessed a bull market in commodities]. For the smallest ones, the minimum buy-in was probably around $5,000."

Exchange-traded notes and exchange-traded funds are investment vehicles through which individuals can buy shares in select portions of the commodities market. The shares are traded as stocks, offering a return as the price of the goods in the selected group, or index, rise.

Both channels are relatively new, and in today's world of instant information, are readily available to anyone with a computer at the click of a button. But the ease with which someone can place their money into the commodities futures pool doesn't necessarily increase their chances of making any money, both Zigler and Passaretti agreed.

Commodities are a notoriously volatile sector, with peak highs one day followed by jarring lows the next. Even in times of seemingly consistent price rises such as these, there really is no sure thing, both men noted.

"You can look at it twofold. Returns for real assets have become attractive, and there's also a diversification benefit," Zigler said. "The downside is, you can have overexuberant exposure to an asset class that bubbles and bursts, and if you're not particularly nimble, you get sucked into the down draft."

Passaretti agreed that the markets in real goods play an important part in supplying diversity to an investment portfolio, with diversity being the operative word here. He said that he often finds himself talking to clients who are eager to sink their money into commodities, and consistently advocates keeping a cool head.

"When you look at it, there's never an all-or-none strategy. It's part of an asset allocation approach," he said.

But gaining exposure to hard assets begins to appear quite attractive in times like these, Zigler said, and the reasons are simple. "At a certain point, when inflation or fear of inflation runs high, alternative investments, such as futures of commodities-based investments, become more attractive, because stocks and bonds start to suffer with the ravages of inflation," he said. "At that point, it's where the commodities brokers suddenly spring to life."

This sort of economic situation has happened before. According to author, and extremely successful investor, Jim Rogers, the type of swing where stock prices go down, inflation runs high, and the price of goods rises is a natural, healthy part of our economy.

"The 20th century saw three long commodities bulls [1906-1923, 1933-1953, 1968-1982], each lasting an average of a little more than 17 years," Rogers writes in Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market, published by Random House in 2007. "The new millennium has begun with another boom in real things."

In his book, Rogers is quite confident that the present bull run in real goods will continue to around 2016, fulfilling the 17-year cycle that has historically proven true. He continues to express this opinion in recent interviews.

Subject To Interpretation 

Others are not so sure. Since at least 2006, investors and commentators have been wondering whether rising commodities prices were the result of a bubble that could burst any day, sending the market into a tailspin. The answer, it seems, depends on who you talk to, or, even, how you translate what people say.

The June 3 testimony of billionaire financier George Soros before a Senate committee investigating the price of oil is a good example of that last instance. Depending on which reports you read, Mr. Soros either said that oil prices have bubbled as a result of speculation, or that classic, long-view supply-and-demand issues were the cause of the price spike.

Likely, Mr. Soros spoke about both those things and a lot more, and even more likely, senators took away from his testimony what best fit their own views on the issue.

It is certainly a possibility that the growth in value of many hard assets will continue over the next decade, Passaretti said. As always, though, there will continue to be price swings, and variables that combine to change seemingly clear situations in an instant. "Like any asset, it's not going straight to the moon," he said.

The lookout onto futures markets is just that: a speculative examination of a period of time that hasn't happened yet. Everything from today must be taken into account, as well as everything that might happen tomorrow. The weather, the political situation in countries around the world, technological discoveries; everything, really, can and does affect the prices of real goods.

The general growth could continue for another decade, as Jim Rogers has predicted, Passaretti said. The real issue for the individual is how to be a part of it without getting burned.

"What people should be asking is, ‘Is this a demographic change or is it a fad?'" Passaretti said. Looking into the future, we have to keep asking ourselves, "What is sustainable as an investment long term"?

Comments

[LearningCurve]

I’m hoping someone will discuss what percent of a retirement portfolio a person might put into commodities ETFs & ETNs. At present I have ~ 5%. I own DBA, DBC, GCC, RJA, & RJI, and Pimco’s Total Return. I don’t intend to buy & sell within these positions but to hold them as a cushion. Meanwhile, I deliberately have attempted to diversify the individual commodities and hold oil and gas in energy overweighted mutual funds. Anyone want to offer a little more theory or critic this approach –particularly for a retired person?