Ever wonder why Jim Rogers prefers commodities rather than the commodity businesses... and why I'm bearish on commodities
This is very short-term and not indicative of any strong results but one just needs to look at the uranium market and see how the commodity has done well in the last few weeks while the stocks of uranium companies have not:
This example illustrates why Jim Rogers prefers owning the commodities themselves rather than the businsses. One just needs to look at the charts of various stocks in the referenced article to see how terrible the stocks have done. To make matters worse, I think some of those companies will likely go bankrupt or end up severely diluting shareholders even if uranium prices go up 50% or 100% from here.
The painful feeling for uranium company shareholders must come from the fact that the bankruptcy or collapse of some actually strengthens the price:
Commodity stock investing is going to end up looking like investing in growth stocks. That is, you will make a killing if you pick the right ones but wrong ones will likely cause massive losses. In contrast, in the last 10 years, you could have invested almost blindly and the market would have rewarded you as long as commodity prices kept going up, which they did.
I'm Still Not A Fan of Commodities
For what it's worth, I'm bearish on uranium and netural to midly bearish on commodities in general. Barring high inflation, I don't see them doing well (except possibly soft commodities.) My opinion is not based on projected fundamentals but due to history and psychology.
The bearish tilt due to history goes like this... If you look at the 70's, the commodity bull market lasted anywhere from 8 years to 15 years (actual numbers depend on the commodity and the index you are looking at; other time periods are mostly similar) If you look at the CRB index, the bottom was somewhere around 1968--note that the DJIA peaked in 1966--and the top was probably in 1981 (I'm just going with rough visual readings off the chart.) But indiviudal commodities differed, with some peaking near the end (oil & gold) while others peaked as early as 1974 (zinc).
The current bull market in commodities started in 1998, when oil (WTIC) was at $12 I believe. So we have had around 10 years of bull market in commodities. It is possible for the commodity bull market to last another 5 to 10 years. But that's an optimistic scenario. Furthermore, it is very important to keep in mind that some commodities may peak early. Maybe copper already peaked but maybe zinc did not. Who knows? Maybe uranium has already peaked? Maybe even oil has. Oil roughly went up from $4 to $40 in the 70's (10x) yet it has already gone from $12 to beyond $120 (10x). None of this means that oil, for example, won't go up. But how likely is it to go from $50 to $250 (5x) in the future? This is why the history is not on the side of commodity bulls right now.
The other big reason to be cautious about commodities is due to market psychology. It is often the case that once the market falls out of love with some sector, it won't return for a while. Immense wealth has been lost by commodity investors--if it's any consolation, other investors have lost huge sums as well--and how many are likely to return and buy up all these uranium, oil&gas, iron ore, or whatever, resource plays? I'll bet not many.
Some would argue that 'this time it is different'. After all, we have countries with massive populations, like China, India, Brazil, among others, growing rapidly. We never had such synchronized growth on this scale in world history. The problem I see is twofold.
First of all, the market already priced in this rosy future for commodities. This is a fact! If you don't believe it, grab mainstream magazines or newspapers from the last 2 years and see if the consensus wasn't for high growth from emerging markets. I'm not talking about some obscure news source; this is mainstream thinking--investors managing billions, such as pension funds and hedge funds, believe in it. Now, one can argue that the prices have collapsed recently and may not reflect past bullish views. That may be true but it still seems risky to me. For instance, even though oil is down to $50 from $140, it has still gone up 4x (say $12 to $50). That is a big increase and seems to imply that the market is pricing in some strong fundamentals compared to 10 years ago (before the rise of EM.) So it may be possible, although we cannot be certain, that the market is pricing most of the strong fundamentals in the future.
The other problem I see with the five most dangerous words in investing is that, although the world has not grown on such a large scale in human history, it has also not maintained any high growth in the past! Even during the glory days of USA's growth in the early 20th century, it was barely able to maintain 10% real growth rates. And when it did have high growth rates, it often ended up with contractions. China's current 9% real growth (up to 17% norminal growth) seems impossible to maintain. Not only has China not posted a negative number, whereas USA does from time to time, this growth rate seems really high. Admittedly, I will note that China may be more akin to USA in the 1800's (rather than the 1900's) so the comparison may be off. USA was also on a gold standard (or a quasi-gold-standard) so extreme contractions were the norm. Also China's numbers may be manipulated by the government so it's hard to say what is the truth. Nevertheless, I think my point that high growth rates seem impossible, even for a superstar growth story like USA in the early 1900's, is worth pondering.
I have no proof that long-term growth has to come down but my suspicion is that it has to come down. We have gone over various reasons in prior blog entries and I don't want to go over them again but let's look at one potential cause that is completely ignored by the mainstream, as well as commodity bulls. I feel that the culprit to the rosy EM growth scenario is going to be 'da environment'. What I am talking about is nature. It is virtually impossible for projected emerging market growth rates to materialize. On top of destroying all the arable land and wildlife, there would be so much pollution that we might actually end up with pollution wars. Ok, the pollution war idea is radical and too sci-fi but the rest of the point stands. If steel and iron ore bulls are betting on high growth in cars from China and India, has any of them considered what would happen if the projected cars actually made it to the streets? Major Chinese cities are already covered in soot and acid rain and if car usae goes up, well, it won't be a pretty picture. That is an example of how projections can make no sense in the real world.
You can still make money off commodities, just like you can make money buying mortgages right now, but consider some of what I have said in your investment decisions.
The Only Hope For Commodities
I think the only hope for commodities--I'm speaking in general; some specific commodities may do well--in the long run is high inflation. I'm not going to go there for the time being since I don't have a strong opinion on inflation. But, having given my bearish view on commodities that I have maintained for several years, commodities may still turn out to be a good investment if you expect high inflation. When I have formed my opinion of inflation, I'll post my views.
The spot price for uranium has surged 25 per cent over the past five weeks, a performance unmatched by the stocks of companies in the uranium sector. From a basket of 56 stocks tracked by Haywood Securities, for example, 42 fell over the last week, three were unchanged, and just 11 saw gains.
This example illustrates why Jim Rogers prefers owning the commodities themselves rather than the businsses. One just needs to look at the charts of various stocks in the referenced article to see how terrible the stocks have done. To make matters worse, I think some of those companies will likely go bankrupt or end up severely diluting shareholders even if uranium prices go up 50% or 100% from here.
The painful feeling for uranium company shareholders must come from the fact that the bankruptcy or collapse of some actually strengthens the price:
“These companies are putting out news that is good for the supply and demand situation, but hurts the individual companies,” said Dundee Securities analyst David Talbot.
Supply is shrinking as uranium producers, stung by the global financial crisis, have been closing mines, delaying developments and cutting production forecasts.
Commodity stock investing is going to end up looking like investing in growth stocks. That is, you will make a killing if you pick the right ones but wrong ones will likely cause massive losses. In contrast, in the last 10 years, you could have invested almost blindly and the market would have rewarded you as long as commodity prices kept going up, which they did.
I'm Still Not A Fan of Commodities
For what it's worth, I'm bearish on uranium and netural to midly bearish on commodities in general. Barring high inflation, I don't see them doing well (except possibly soft commodities.) My opinion is not based on projected fundamentals but due to history and psychology.
The bearish tilt due to history goes like this... If you look at the 70's, the commodity bull market lasted anywhere from 8 years to 15 years (actual numbers depend on the commodity and the index you are looking at; other time periods are mostly similar) If you look at the CRB index, the bottom was somewhere around 1968--note that the DJIA peaked in 1966--and the top was probably in 1981 (I'm just going with rough visual readings off the chart.) But indiviudal commodities differed, with some peaking near the end (oil & gold) while others peaked as early as 1974 (zinc).
The current bull market in commodities started in 1998, when oil (WTIC) was at $12 I believe. So we have had around 10 years of bull market in commodities. It is possible for the commodity bull market to last another 5 to 10 years. But that's an optimistic scenario. Furthermore, it is very important to keep in mind that some commodities may peak early. Maybe copper already peaked but maybe zinc did not. Who knows? Maybe uranium has already peaked? Maybe even oil has. Oil roughly went up from $4 to $40 in the 70's (10x) yet it has already gone from $12 to beyond $120 (10x). None of this means that oil, for example, won't go up. But how likely is it to go from $50 to $250 (5x) in the future? This is why the history is not on the side of commodity bulls right now.
The other big reason to be cautious about commodities is due to market psychology. It is often the case that once the market falls out of love with some sector, it won't return for a while. Immense wealth has been lost by commodity investors--if it's any consolation, other investors have lost huge sums as well--and how many are likely to return and buy up all these uranium, oil&gas, iron ore, or whatever, resource plays? I'll bet not many.
Some would argue that 'this time it is different'. After all, we have countries with massive populations, like China, India, Brazil, among others, growing rapidly. We never had such synchronized growth on this scale in world history. The problem I see is twofold.
First of all, the market already priced in this rosy future for commodities. This is a fact! If you don't believe it, grab mainstream magazines or newspapers from the last 2 years and see if the consensus wasn't for high growth from emerging markets. I'm not talking about some obscure news source; this is mainstream thinking--investors managing billions, such as pension funds and hedge funds, believe in it. Now, one can argue that the prices have collapsed recently and may not reflect past bullish views. That may be true but it still seems risky to me. For instance, even though oil is down to $50 from $140, it has still gone up 4x (say $12 to $50). That is a big increase and seems to imply that the market is pricing in some strong fundamentals compared to 10 years ago (before the rise of EM.) So it may be possible, although we cannot be certain, that the market is pricing most of the strong fundamentals in the future.
The other problem I see with the five most dangerous words in investing is that, although the world has not grown on such a large scale in human history, it has also not maintained any high growth in the past! Even during the glory days of USA's growth in the early 20th century, it was barely able to maintain 10% real growth rates. And when it did have high growth rates, it often ended up with contractions. China's current 9% real growth (up to 17% norminal growth) seems impossible to maintain. Not only has China not posted a negative number, whereas USA does from time to time, this growth rate seems really high. Admittedly, I will note that China may be more akin to USA in the 1800's (rather than the 1900's) so the comparison may be off. USA was also on a gold standard (or a quasi-gold-standard) so extreme contractions were the norm. Also China's numbers may be manipulated by the government so it's hard to say what is the truth. Nevertheless, I think my point that high growth rates seem impossible, even for a superstar growth story like USA in the early 1900's, is worth pondering.
I have no proof that long-term growth has to come down but my suspicion is that it has to come down. We have gone over various reasons in prior blog entries and I don't want to go over them again but let's look at one potential cause that is completely ignored by the mainstream, as well as commodity bulls. I feel that the culprit to the rosy EM growth scenario is going to be 'da environment'. What I am talking about is nature. It is virtually impossible for projected emerging market growth rates to materialize. On top of destroying all the arable land and wildlife, there would be so much pollution that we might actually end up with pollution wars. Ok, the pollution war idea is radical and too sci-fi but the rest of the point stands. If steel and iron ore bulls are betting on high growth in cars from China and India, has any of them considered what would happen if the projected cars actually made it to the streets? Major Chinese cities are already covered in soot and acid rain and if car usae goes up, well, it won't be a pretty picture. That is an example of how projections can make no sense in the real world.
You can still make money off commodities, just like you can make money buying mortgages right now, but consider some of what I have said in your investment decisions.
The Only Hope For Commodities
I think the only hope for commodities--I'm speaking in general; some specific commodities may do well--in the long run is high inflation. I'm not going to go there for the time being since I don't have a strong opinion on inflation. But, having given my bearish view on commodities that I have maintained for several years, commodities may still turn out to be a good investment if you expect high inflation. When I have formed my opinion of inflation, I'll post my views.
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