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December 14, 2007

Why Coal (and other Commodities) Should Be in Your Stocking This Year....
by Emanuel Balarie

...and the next year....and the year after that!

For several years now, commodities have garnered attention because of their prolific appreciation. The price of oil has climbed by over $80/barrel during this first stage of this bull market, gold prices have more than tripled in price, and soybeans, corn, wheat and coal have suddenly become part of the investor's vocabulary. At the same time, however, it seems that while investors are now more familiar with commodities (in the general sense), they are still apprehensive about finally taking the steps to add commodities to their investment portfolios. The reasons vary, but it has a lot to do with the fact that most investors focus on the fact that prices are too high (gold at $800/ounce, for instance). As a result, the average investor feels more comfortable waiting for the next bull market in commodities, rather than being the fool that buys in at the "top".

Interestingly enough, not only is it not too late to invest in the commodity bull market, but it is also perhaps one of the best times to start investing. In this article, I will not list the fundamentals for why I believe we are still in the first half of this commodity bull market. I have written about this topic on various occasions, and I write about it in detail in my new book,Commodities for Every Portfolio: How You Can Profit from the Long-Term Commodity Boom. I recommend buying this as a Christmas gift for yourself or your skeptic friend! Instead, I will make the case for why I believe this is probably the best time (since the start of this bull market in 2001) to actually allocate a portion of your portfolio to the commodity markets.

The Last Seven Years

I fully realize that most people will initially scoff at my belief that now is a much better (and critical) time to buy commodities. How could I possibly believe that buying gold today( when it is trading at $800/ounce) is better than buying gold seven years ago (when it was trading around $250/ounce)? Or how could I argue that oil at $90/barrel is a better investment than oil at $15/barrel? Indeed, if one were to look simply at the price of commodities, my argument would not make sense. However, if you look at the bigger picture, it becomes clear that investing in the second leg of this bull market is much more important.

Consider, for instance, the potential investments (and their returns) of the previous seven years. There is no question that the commodity markets have tallied significant gains. But so have other investments. For instance, while commodity bulls point the gains they made investing in the energy sector, real estate investors can readily point to the appreciation that they experienced by investing in housing. While gold bugs boast about the massive gains that they accumulated by buying gold at $300/ounce, stock market investors simply point at the fact that Google has moved from just over $100 in 2004 to over $700 today.

Indeed, it is clear that those that have missed the "boat" during this first stage of this bull market have had ample opportunity to ride other crafts to financial gains. In a sense, the financial opportunities of this decade have been ample and widespread. However, this unprecedented and goldilocks scenario is clearly coming to a screeching halt. As a result, investors can no longer afford to ignore the benefits of holding commodities in their portfolio.

The Next Several Years

The economic environment of tomorrow paints a picture that is polar opposite to what has transpired in the previous years. Whereas investors were able to profit from real estate gains (via the real-estate bubble), they are now realizing losses (via the real-estate burst). Whereas investors were able to profit from a rising stock market (due to consumer spending), the housing decline and upcoming recession will inevitably result in a bear market in stocks. And while the skewed and archaic fed data (think: the core CPI) has failed to warn investors about inflationary pressures, the massive printing of money to finance the war in Iraq, Afghanistan, and other government expenditures will undoubtedly lead to inflationary pressures that will erode the wealth of many investors.

In short, the benefits of commodities can serve as a remedy for the problems of tomorrow. While I have always espoused the profitable reasons for investing in commodities, I believe it is now more a question of protecting your wealth. In other words, the intrinsic benefits of holding commodities in your typical stock and bond portfolio far out way the potential gains you might see. Now don't get me wrong. I still believe commodity prices will soar for another decade or so, but if you are concerned about inflation, a bear market in stocks, and the inevitable recession -- commodities make sense.

Why Commodities Belong In Your Stocking

So why exactly do commodities still make sense? And why do they belong in your stocking? Well consider the following study conducted by a couple professors and the gifts (or benefits) that commodities provide investors this holiday season.

In 2004, Professor Gary Gorton of University of Pennsylvania and K. Geert Rouwenhorst of Yale School of Management published "Facts and Fantasies about Commodity Futures". In the study, the two professors examined the long-term relationships of these three different asset classes. Their results were groundbreaking on a number of levels. First, the study shattered several ongoing myths about commodity futures. One of these myths was simply that commodities are more volatile than stocks. Looking back over a period of 45 years, the professors found the opposite to be true; the risk premium for stocks was greater than that for commodities.

Gift #1: Commodities provide investors with a hedge against a bear market in stocks.

In addition to debunking several myths about commodities, Gorton and Rouwenhorst concluded that over a prolonged period of time, commodity futures were negatively correlated to stocks and bonds. This, of course, makes perfect sense. Consider for example the effects higher commodity prices have on companies. As the price of commodities rise, companies have to pay more to make those products. In turn, they will have to pass on those costs to the consumer. Since the price of the product is now more expensive, not as many consumers will buy the product. The end result is lower earnings, and lower stock price.

Gift #2: Commodities provide investors with a hedge against rising inflation.

In addition to commodities being negatively correlated to stocks (and thus serving as a hedge against a bear market in stocks), the study as mentioned that commodity futures were positively correlated with inflation. In other words, commodity prices increase with rising inflation and decrease with declining inflation. Again, this makes perfect sense. Throughout the 1980's and early 90's, a period of low inflation, commodity prices were in a decline. Today, commodity prices are increasing in the midst of rising inflation. For instance, as the price of corn, soybeans, and other food products rise in price, you will have now have to pay more for your food products (See Food Inflation Article). While rising inflation erodes the purchasing power of your dollar (and subsequently diminishes your wealth), investing some of your wealth in tangible real assets can counteract the inflationary pressures.

Gift # 3: Commodities provide investors with the opportunity to profit from the greatest generational bull market of our time.

Of course, commodities can still provide investors with the opportunity to profit from the greatest generation bull market of our time. While there might be pullbacks and consolidation along this bull ride, the sheer demand for commodities from China, India, and other emerging economies will continue to push commodity prices higher. Additionally, while many investors continue to focus on how high commodities prices have risen over the last 7 years, they fail to realize that commodity prices were in a bear market for the previous 20 years. And if you look back at the history of commodity bull markets, they have all lasted longer than 15 years.

It is becoming evident that commodities should have a place in an investors' portfolio. It is no longer simply a matter of whether or not you believe that we are in a bull market or a bubble, but it is a matter of properly diversifying your investments. While diversification might not seem as important when most every investment is going up, it becomes increasingly important during times of economic uncertainty. Hopefully this Christmas Santa will bring you some coal....or oil...or gold. Personally, I prefer gold.

Say tuned for the official launch of www.commoditynewscenter.com in early 2008. With commodity news, pertinent commentary, quotes, and trading tools, CNC is poised to become your home for commodities online. I will also be launching a daily blog and send my subscribers a free report on which commodities to own...and not own...in 2008!

If you are interested in receiving this report .. You can sign up for a free newsletter here.

Emanuel Balarie
CommodityNewsCenter.com

Emanuel Balarie is the Editor of Commodity News Center and the author of the highly acclaimed book, Commodities For Every Portfolio: How You Can Profit From The Long-Term Commodity Boom.

Mr. Balarie's industry experience ranges from commodity stocks to futures to alternative investments. He is a highly regarded advisor to clients and institutions on the commodity markets and managed futures investments, and has had his research published all over the world. In addition to his several CNBC appearences, Balarie is frequently quoted in financial publications such as The Wall Street Journal, Reuters, Marketwatch and Barron's.

Mr. Balarie was one of the few market strategist to correctly predict this multi-year bull market in commodities, the decline in the US dollar, and the downturn in housing.

The risk of loss in trading commodity futures contracts can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition.

Copyright © 2005-2008 Emanuel Balarie

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