It was 1983; the US had just made its way out of a serious recession where the nationwide unemployment rate was 10.8%, the highest since the Great Depression. Much of this "stagflation" was caused by the end of the Gold Standard for the dollar in 1971, oil shocks in 1973 and 1979, and the changing of our economy from manufacturing to services. Determined to wring inflation out of the economy, Federal Reserve chairman Paul Volcker slowed the rate of growth of the money supply and raised interest rates. The federal funds rate, which was about 11% in 1979, rose to 20% by June 1981. The most popular computer was the Commodore 64. Microsoft was in the process of releasing Windows and Lotus 1-2-3 was the original "killer app". McDonald's created the Chicken McNugget to diversify its menu and John Landis introduced us to a rising comedian named Eddie Murphy. As Billy Ray Valentine, a down on his luck hustler, his life is switched and he becomes employed by Duke & Duke, Commodities Brokers. In this memorable scene, Murphy's character is learning the basics of the commodity trade.
Commodities are agricultural products... like coffee that you had for breakfast... wheat, which is used to make bread... pork bellies, which is used to make bacon, which you might find in a 'bacon and lettuce and tomato' sandwich…….. And then there are other commodities, like frozen orange juice... and GOLD. Though, of course, gold doesn't grow on trees like oranges.
Today, the Fed funds rate stands at 0.25%, the European Union abd China are in economic purgatory, and we are barely 5 years removed from the greatest upheaval in the global financial system. The technology developed 30 years ago is still with us today, but instead of putting a man on the moon, it is busy planning our day, connecting with high school sweethearts, and sending school textbooks the way of the dinosaur. However, we still drink coffee, eat BLT's, and adorn ourselves in gold. The basic human needs of food, water and shelter have not changed as well.
Rapid urbanization, higher standards of living and a growing middle class are all contributing to increased global consumption and boosting the demand for essential commodities such as food, energy and metals. The single factor that we are living longer due to greater health awareness and medical breakthroughs, establish a greater need for resources. Over the last several years there has been a dramatic shift in developing countries, such as China, adopting more of the institutions and mechanisms of a market economy. This shift has been, and we believe it will continue to be, a significant contributor to rising demand for commodities as well.
With corporate bond and U.S. Treasury rates near 100-year lows after a 30-year steady decline, along with major stock indexes at all-time highs, investors everywhere are pondering the consequences if interest rates begin to rise. Credit expansion helped fuel much of the economic growth of recent decades, and many investors recognize they have come to rely on investments linked to favorable rate conditions. Long-side commodity trading was the most reliable performer during acute and sustained rising interest rate periods in the past.
Holding a physical commodity is not practical for most investors, but the futures markets provide an alternative way to seek exposure to commodities. Futures and options contracts are traded on exchanges around the world. We intend to invest in a combination of exchange listed commodity futures contracts and commodity-linked instruments through ETF's and Mutual Funds. Unlike some commodity investments, the funds we will focus on are not partnerships and do not issue K-1 tax forms. Rather taxable gains and losses are reported on a Form 1099.
Historically, commodities can be volatile. In addition, many passive commodity indices can be concentrated and have their returns dominated by one sector of the commodities market. The S&P GSCI is 70% energy, while BCOM 40% and DJCI are 30%. The volatile nature of commodities and the concentration risk can be viewed negatively by the average investor and may prevent them from including commodities in their asset allocation plans. By dynamically rebalancing and seeking to manage the risk profile of the commodities portfolio while seeking a more diversified composition, we believe the average investor will have a higher degree of confidence to include commodities in their allocation mix. We believe now is the time for a strategic allocation to an actively managed commodities portfolio.