Throwing resources at raw materials
When the dot-com mania of the late 1990s ended in ruin, many burned investors vowed, “I’ll never do that again.”
Which is one reason the boom in prices of oil, gold, wheat and other commodities in this decade -- and particularly in the first quarter of this year -- has been viewed with plenty of suspicion.
You’ve seen this movie before, you figure.
But as the first quarter ends, it’s going to be tough for people to look away from the gains that commodity-related investments racked up.
One of the most popular mutual funds designed to track commodity prices, the Pimco Commodity RealReturn Strategy fund, is up 16% year to date. By contrast, the Standard & Poor’s 500 stock index is down about 10%, including dividends.
By now, most everyone knows the basic story behind the commodity bull market. The strongest global economic growth in three decades has fueled robust demand for real stuff: oil to power cars; iron to build bridges, dams and skyscrapers; and grain to feed hundreds of millions of wealthier consumers, especially in the developing world.
The Reuters/Jefferies CRB index, which measures the price of a basket of 19 commodities, has risen 107% since the end of 2001.
The S&P; 500 index is up 14% in the same period. Throw in dividends and the return is about 28%.
So stuff has done a lot better than stocks, generally.
And therein lies the dilemma for many investors: Could it be too late to buy into commodities?
It’s always hard to know where a bull market powered by fundamentals ends and a bubble begins. Yet the action in many commodities over the last 15 months has felt bubbly enough.
Wheat, for example, went from $5.01 a bushel at the beginning of 2007 to (briefly) more than $12 this month before pulling back. The price ended Friday at $9.90 a bushel in Chicago futures trading.
All investing ultimately is about supply and demand, of course. But when you’re investing in a company, you’re also betting on a management team. A bond is a bet that interest and principal payments will be made.
With raw materials, it’s nearly all about supply and demand -- demand not just from actual users of the stuff, but from hot-money speculators as well.
The biggest risk facing commodities now may be the health of the global economy. If the rest of the world is about to follow the U.S. into a sharp slowdown or worse, prices of raw materials could crumble in the near term, in part because hot money could flee.
That’s the best argument for going into commodities slowly, if you go at all.
Looking out a few years, however, investors who are bullish on raw materials see the story staying the same: Supplies of many commodities remain stretched compared with expected long-term demand, says Robert Levitt, who manages more than $400 million at Levitt Capital Management in Boca Raton, Fla.
“We don’t have any inventories. We’re out of stuff,” says Levitt, who invests in commodity-related stocks worldwide for clients.
If you expect the dollar to continue losing value, that too could be good for commodities. Because raw materials typically are priced in dollars, a weak greenback makes them cheaper for buyers in countries with rising currencies.
Dan Culloton, an analyst at investment research firm Morningstar Inc. in Chicago, says the right reason to have a small stake in commodities isn’t the returns of the last five years, which he (and many others) believes are unlikely to be duplicated in the next five years.
Rather, he says, commodities simply offer a way to increase diversification and hopefully give you something that will buffer other investments in your portfolio.
If you want to add commodities to your mix, Wall Street has come up with all sorts of investment choices, which also means there are all sorts of ways to hurt yourself.
For the sake of simplicity and diversification, many investors will choose the fund route. Some tips on basic commodity fund options:
Traditional mutual funds. There are about 180 mutual funds classified by fund tracker Lipper Inc. as natural resources funds. Many are heavily invested in energy stocks, so their fortunes rely primarily on the outlook for oil, natural gas, coal and other energy sources.
Even the T. Rowe Price New Era fund, which can cast a wide net in the natural resources sector, has about 73% of assets in energy-related issues, says fund manager Charles Ober. He says he likes the prospects of the oil-field services companies in particular because he expects no letup in oil exploration.
The other fund alternative for commodities, and a favorite of many financial pros, are portfolios such as Pimco Commodity RealReturn and Oppenheimer Commodity Strategy Total Return.
They don’t own actual commodities but use “derivative” securities to try to replicate or beat the performance of baskets of commodities.
They’ve worked well recently, but investors considering these funds should take a close look at their history, risks and tax issues, as detailed in their prospectuses.
Other funds. The bull market in raw materials has spawned a horde of exchange-traded funds (ETFs), exchange-traded notes (ETNs) and unit investment trusts (UITs) that target commodity-related investments -- either the materials themselves or stocks of companies involved with them.
If you really wanted to bet on nickel, for example, there’s the IPath Dow-Jones AIG Nickel Total Return ETN.
Chip Hanlon, head of investment advisor Delta Global Advisors in Huntington Beach, manages a UIT that invests in agriculture shares worldwide.
Given the growing global demand for food, he says, “We see the agricultural segment as probably the most rock-solid fundamental story in the whole commodity area.”
With ETFs and ETNs, here’s a great way to see what’s out there: Go to the website SeekingAlpha and enter “commodity ETFs and ETNs” in the site’s search field. Click the top link for a wealth of resources.
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