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January 24, 2007

Double Down on Commodities?
by David Shvartsman

Goldmand Sachs and Deutsche Bank are advising clients to double down on their commodities bets this year, Bloomberg reports. From Bloomberg.com:

Anyone who followed the advice of Goldman Sachs Group Inc. last year and invested $10 million in the Goldman Sachs Commodity Index would have lost 15 percent, or $1.5 million.

Like so many of Wall Street's best and brightest, Goldman, the biggest securities firm by market value, says it wasn't wrong, just early, and to expect an 8.1 percent return in 2007.

"The long-term secular story is very much intact," Jeff Currie, global head of commodities research at New York-based Goldman, told customers in London earlier this month. That's the same outlook provided 13 months ago by Arun Assumall, the firm's London-based head of commodities sales.

Like Goldman, Deutsche Bank AG isn't discouraging anyone from doubling down in what increasingly looks like a bear market. Germany's largest bank in September said oil will trade between $60 and $70 a barrel this year, well above the $49.90 fetched last week. Barclays Capital, the securities unit of the U.K.'s No. 3 bank, said four months ago crude won't drop below $60.

As losses mount in copper, oil and sugar, these firms say the 20 percent plunge in commodities, as measured by the Reuters/Jefferies CRB Index, since May offers a chance to buy before demand from China and India causes a rebound. History shows otherwise. The CRB index dropped at least 20 percent six times since 1970, and on average, fell a further 7.7 percent before bottoming.

First off, as far as their rationale for investing goes, I hope you've got a better command of return-related math if you're taking their advice. If Goldman is calling for investors to stay put in the index for a multi-year holding period, that's one thing. But the rationale for this call seems to be more of a "wait till next year" justification.

As the article reports, "Goldman...says it isn't wrong, just early...to expect an 8.1 percent return in 2007".

Well, if you're banking on a one year catch up performance, I've got news for you. After suffering a 15 percent loss in the GSCI last year, you'll need a gain of about 17.65 percent this year just to break even. Banking on an 8.1 percent gain this year isn't going to make you whole.

Okay, maybe that's just the way they interperated the call for the article, or I'm just taking the wrong impression from that report. But it is a point to consider.

Moving on, it's interesting to see these guys touting the whole China and India demand factor as rationale for getting in at this date. We haven't seen the big slowdown in China yet that everyone's been anticipating for so long. And the whole Asian demand story is what's been partly responsible for powering the commodities higher since 2001.

They say this drop in the commodity indexes reflects a buying opportunity before the next wave of Chinese and Indian demand takes commodities higher. But you know what? I don't think it's going to be as easy as all that. I think that after a one-two year correction in the overall commodity indexes (CRB and GSCI to name two of the most widely followed), the next leg up in the commodity bull market will be powered by an altogether different story.

The demand from Asia will likely remain as the emerging economies industrialize, produce more goods, and consume more resources, but I think by that time this will be the accepted background foundation story to the ongoing commodity bull market.

When the "secular bull" really heats up (if Bannister, Rogers, et al. are correct in their long-term forecasts) I think you'll begin to hear people voicing "new" explanations for the rise in commodities and tangible asset classes. More people will have picked up on the story of rising global liquidities, the shift from paper to tangible assets, and the increased involvement of pensions and investment funds in the commodities arena.

By that time you will also begin to see more involvement at the retail level as well. Maybe someone you know will begin speculating on commodity futures or you'll feel more comfortable adding commodity ETFs and resource focused mutual funds in your portfolio.

Maybe Jim Rogers' book, Hot Commodities, will have shipped its revised third edition. Or maybe, as Clyde Harrison told me in 2003, you'll see Maria Bartiromo reporting from the Chicago grain futures pits. We'll know better when that time arrives.

In the meantime, I want to make note of the fact that we should look behind the indexes and take a look at individual commodities and the various commodity subgroups. We should probably become more selective and look to the fundamentals and performance characteristics of individual commodities and their related subgroups, whether they be grains, softs, or precious metals.

You might want to zero in and be more selective by examining the bull and bear case for each commodity group or each individual commodity, a theme that was stressed in our July article, "The Case for Commodities".

As far as the indexes go, each of the leading commodity indexes reflects a certain weighting (or perhaps a "total return" makeup) that might influence their performance. Take a little bit of time if you haven't already (something I'm trying to learn to do) to check out the various commodity indexes and familiarize yourself with the differences between them. It could help you understand a bit more about the commodity complex.

David Shvartsman
Finance Trends Matter

Copyright © 2005-2008 David Shvartsman

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