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The Commodities Boom: Converting Dollars to Real Stuff
(September 28, 2003) Another strong week in gold prices reinforces a trend that has been gathering steam over the past couple of years: the return of commodities as a respectable investment. After two decades of a booming US market in equities, bonds, and a host of other financial abstractions, there’s a growing worldwide interest in buying something real with our fading dollar.
For the general public, commodities as investments have earned a bad reputation. Just mention the commodities market to your average person, and all sorts of frightening images come to mind: volatile markets, the risk of margin calls, deflation versus inflation, and the difficulties in making money in markets subject to both acts of God (droughts, frosts, mad cow disease) and human actions, including the vagaries of trade policies, manufacturing needs, demand patterns, and war.

And that’s forgetting the old nightmare of going long a few contracts of soybeans, neglecting to sell them by delivery day, and having a convoy of trucks come and deliver your position onto your front lawn.

There’s also the perception that commodities trading is not unlike a poker game: A number of players come to the table, each with a certain amount of money, and they spend time dealing, bluffing, and hiding their cards from each other. Piles of chips move around the table, but no new wealth is created. Furthermore, commodity speculators are predominatley bullish, and during the deflationary 1990s, there were few winners in the commodities game. So, it’s not hard to imagine that those that did win simply lifted their gains from the pockets of the losers. That in a nutshell is the unappealing zero-sum aspect of commodities.

To further turn your average investor against commodities, increase the level of confusion by using such terms as crush spreads, naked straddles, butterflies and backwardation. At this point, you have pretty much scared off any rational human being who is not willing to make the study of commodities a full-time job. And, as Larry Williams writes in Futures magazine (special issue 2003):

“The math of commodity speculation is simple. About 80% of the participants lose money trading. Only 20% are winners. Nowhere else is there as much money waiting to be transferred from one group of people to another. These are hard facts that have not changed over the years.”

Nonetheless, at heart, commodities are the building blocks of our world. Commodities are agricultural products, raw materials, and metals that reflect the hard, cruel realities of supply and demand, shortage and glut, producers and users. Commodities are those components of our nasty old material world that are available at a price. The constant question is, at what price?

Such “stuff” as commodities will never have the glamorous gloss that stockbrokers and the mutual funds industry impart to common stocks. Billions of dollars are spent annually in marketinga glorious picture of how your investment in equities (of their choosing) will bring about so many wonderful results for you and the world at large. Your dollars, spent with them, will create value, encourage and fund entrepreneurs, found innovative enterprises, and generally help nurture human progress and commercial efficiency, all the while ensuring that your kids can go to properly expensive colleges and your retirement will be one long, spendthrift vacation.

And, right up until stocks peaked in the spring of 2000, that warm and fuzzy stock market daydream seemed pretty believable. But things change.

Today, worldwide, prices and interest in commodities are up. The past couple of years have seen strong markets, from wheat to beans, lumber to beef, nickel to cocoa, and oil to gold. Although virtually ignored during the 1990s, the whole spectrum of commodities is staging a strong comeback. Just recently, a single seat on the largest commodity exchange, the New York Mercantile (Nymex) sold for $1.6 million - roughly three times what one sold for in the year 2000.

As the Financial Times reported under its “Comment and Analysis” column of 9/18/03,

“Across a wide range of commodities, world prices for raw material are hitting levels not seen in years or, in some instances, decades. Investors are buying record volumes of commodity futures, as even traditionally conservative pension funds are starting to dip a toe into the commodity markets. Many investment banks are expanding their trading desks. New investment funds are being set up.”

What’s up with commodities all of a sudden? A number of different factors contribute. Agricultural products have been hit especially hard by the recent drought in Europe. China’s burgeoning industries have meant a growing demand for nickel, copper, aluminum and other base metals. Precious metals have been supported by weakness in the dollar (and other currencies), and renewed investment demand. Oil prices have gone up and stayed up, mostly because of war in the Middle East – and higher oil prices make it more expensive to grow or mine the other commodities, thus ratcheting up the price of just about everything.

And of course, commodities are measured in dollars, and the dollar has gotten hammered over the past few months. By holding a position in commodities, or stocks in oil, mining, or natural resource companies, you hedge yourself against weakness in the US dollar. In an inflationary environment, “stuff” gets more expensive as the dollar gets weaker.

Of course, for the typical investor who will own stocks or mutual funds, and consider no other alternatives, there are commodity surrogates available. Stocks in oil companies with substantial oil reserves stand to hedge your portfolio against higher petroleum prices. Natural resources are represented by equities in those paper companies whose assets include a lot of forestland. Or you can buy mining companies who stand to profit from increases in metals prices. There are a variety of mutual funds which concentrate on these various sectors.

But, as commodities go, gold is one of the few that is relatively easy and convenient to take a physical position in. Gold doesn’t take up much space, it’s imperishable, and its appeal is universal and eternal. And gold will hedge against a further fall in the dollar, which makes it the perfect monetary asset with which to diversify an investment portfolio that is otherwise entirely denominated in US dollars (i.e., the holdings of most everyone in the United States).

“It’s like an insurance policy – people go into gold because something else isn’t working.” –John Hathaway of the Tocqueville Gold Fund (up 22.8% over the past year), to Jane Kim, in “Gold Funds Show the Midas Touch,” Wall Street Journal, 9/18/03.

Gold prices this past Thursday in New York trading achieved a 7 ˝ year high of $394.80, settling that day at $385.90. On the heels of that record-setting 21st century gold price, the WSJ devoted all of two lines of text to the event the next day. Gold, once again, gets no respect in the US.

Gold is still the unknown monetary metal for most Americans, and is it any wonder the way the media, both popular and financial, ignore it so thoroughly? Gold is up almost 50% from its April 2001 low of $256, yet a tiny minority of Americans have taken a position in gold or gold-mining shares.

This current lack of recognition for gold, perversely, bodes well for its future. It signals an enormous unrealized market for gold, that being the American investor whose financial future is currently dependant on the trillions of US fiat dollars in existence holding their value in the decades to come.

Buying gold today still puts you well ahead of that crowd.


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