What You Should Do Right Now - Roger Nusbaum

An interview with Roger Nusbaum, one of the most respected financial advisors and well-known investing columnists in the U.S., in which he examines the market and the state of commodities.

HardAssetsInvestor.com (HAI): There's no other way to put this, Roger: This market is crazy. How should investors respond to current developments?

Roger Nusbaum (Nusbaum): Regarding the stock market, I've been in the "bear market camp" for a long, long time. I'm not talking about an apocalyptic bear market, but a real bear market. And that's what we've got.

At this point, the stock market is down a lot: It's off 27% from its peak, versus the normal peak-to-trough fall of 30% in the average bear market. So despite all the fear that exists, all the crazy things that stand before us, we know that the market is already down a lot. And that matters.

HAI: So this is an opportunity?

Nusbaum: To be clear: I'm not calling for investors to "Buy Stocks Now!" like you see on the TV ads from time to time. But on Wednesday, I did take a little bit off of my SDS ((ProShares UltraShort S&P 500 ETF)) position. So today, I am a little bit less hedged than I have been. I'm still 25% in cash, with some in SDS. But there's a little less risk of the market going down a lot now that it's already gone down a lot.

That said, all the things that people are worried about ... well, I'm right there with them. But even if the economy goes down a lot from here, the market discounts this ahead of time. This market started rolling over even before we knew how big the risks in the markets were. The current bear market actually started rolling over quietly last October, if you take a look at the charts; Q4 of 2007 was down a bit.

There is less fear about going down a lot from here, but there is not much expectation that we will start to go up. I optimistically think we might start to turn up in the second quarter of 2009.

HAI: We've seen a huge pullback in the commodities market - Materials and Commodities are the worst-performing sectors recently. What do you think of commodities in general, and also specifically about things like oil and gold?

Nusbaum: I view oil and gold as two completely different animals.

Looking at gold, I am of the opinion - and this is why I hold gold and have held some gold for clients as long as I've been managing money - that if something really bad happens, I expect gold will go up. That was the case in 2001, obviously, but it was also the case recently with the 777-point one-day drop in the Dow.

Gold is getting crushed today [Wednesday, October 1, 2008], but it does seem that it's generally been working higher through most of this crisis. From the standpoint of looking to own something that goes up if a nasty outlier occurs, gold is it.

I wouldn't hesitate to buy gold right here, right now, if I were setting up a new account.

HAI: Are hedge funds and forced selling contributing to the downturn in commodities, and the volatility in gold?

Nusbaum: They may or they may not be. It's hard to say for sure.

The totality of what's going on in the economy and the markets is causing all types of normal relationships to break down. As I try to navigate this, a lot of the normal relationships that exist between asset classes are not working right now. That's happened before in times of panic, and it's happening again. It makes for a tougher go as an investor. Maybe you can explain it and maybe you can't, but you're better off realizing that this just happens, regardless of the reason.

HAI: What about oil?

Nusbaum: All that stuff I said about gold does not apply to oil, in my opinion. I think people view oil as a barometer of economic activity in the short term. From that standpoint, oil is trying to tell us something. The move up from $88/barrel in February to $147/barrel this summer, and the velocity with which that occurred, really did not make a whole lot of sense. The decline probably doesn't fundamentally make sense when you think about the long term, either. But over the short term, anything goes.

The underlying statistics, however, are strong: In the U.S., we use 25 barrels for oil per capita; in China, it's somewhere around 2 barrels per capita and in India, it's around three-quarters of a barrel. The China and India numbers are moving up. They may ebb and flow, demand may follow a sawtooth pattern, but it's going up.

I view that as being a more important long-term dynamic. I was never in the $200/barrel camp. It's funny, when oil moves up, they bring out all the $200/barrel commentators; when oil moves down, they bring out all the $50/barrel commentators. When oil started to come down from the $147/barrel high, I thought it would settle in the $115-$120/barrel range. I was wrong, but that still looks like a good intermediate-term resting place.

Still, for the short term, oil is a voting mechanism for near-term expectations regarding the global economy.

HAI: Would you allocate to commodities now, and how much exposure would you be looking for?

Nusbaum: I believe in always maintaining a diversified portfolio. You can change weightings now and again; that sometimes needs to be done. But in terms of exposing clients to commodities, I typically keep gold at 2-3% of the portfolio. And then, as opposed to using a broad-based commodity wrapper, I own soft commodities for clients with a higher risk tolerance through the PowerShares DB Agriculture ETF (DBA).

I'm not a real fan of adding oil, which a lot of the broad-based commodity products have large exposure to. Oil is too volatile.

The way I have oil in the portfolio is through stocks, and more narrowly, through Statoil (STO) - the big integrated Norwegian company. It's 75%-80% unhedged. I've owned it for years. I had a lucky sale of it in May, and since then it's been crushed. But in terms of owning oil, paying dividends and not dealing with the risks of owning futures, Statoil might make sense.

That said, let me be clear: If oil goes to $50/barrel, Statoil will be crushed.

HAI: In the past, you've been a big fan of investing in natural-resource-rich countries. Does that still hold?

Nusbaum: Yes, generally. I still love Australia. I still have exposure to Brazil. I think of Norway as a commodity country, and I still have exposure there.

For me, those economies are driven on different things than the U.S. economy. Because they are commodity-driven, these countries tend to be at different points at their economic cycle than the rest of the world. That creates a potential zigzag effect. What that means is not decoupling - that these economies will move independent of the others. But for example, Brazil has gotten crushed recently. But Brazil's market high came in June this year, while S&P peaked in October of 2007.

When we start to turn into a recovery, I suspect you'll see different countries turn up sooner. I think the best chance is for the surplus countries, which are generally the commodity countries.

One country I have exposure to is Chile, through one of its big banks. Chile is slowing down. But I think they are dealing with cyclical downturns. That compares with the U.S., which is facing something that drifts more into the nature of secular or systemic. I don't think it's apocalyptic, but there is a visible path to continued below-normal returns. I think some of the smaller countries have a chance of a normal cyclical downturn, and then a normal bull market will return faster than in the U.S.

Also, the further you get away from the U.S., perhaps, the more diversification you get. Chile, for instance: Only 15% of its exports go to the U.S., so you have a better chance for hitting the growth numbers your financial plan calls for.

HAI: Any final thoughts for people staring down the really scary markets right now?

Nusbaum: People care more about the market than the fundamentals that are causing it. And where we are right here, right now, there is nothing abnormal about the market. Big company failures? We've seen that before. Market down a lot? Yes, we're down about 30%, but that's exactly the average for bear markets. Earlier this decade, the stock market was cut in half. Markets tend to work through these things. Whatever's going on in your portfolio, more emotion will not make anything better.

I wrote years ago about how to pick an exit strategy and having a discipline to stick to it during tough times. Realize what the market has done, and what this feels like. You'll get another chance to confront a bear market later. You'll see it coming: The market will start slowly rolling over. Most people will ignore it or say it's not happening. But if you have an effective defensive strategy in place, and you can be as unemotional and detached as you can be, it will pay off for you next time around.