Asset Class of the Next Generation
The Daily Reckoning
Johannesburg, South Africa
Tuesday, April 05, 2005
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*** Waiting for a fat tail crash to add a little excitement to our lives..."lucky" homeowners...
*** Indebted Americans sign their lives away...a complicated system of affirmative action puts even more emphasis on race...
*** Goldman Sachs is up in arms...the urban legends of the commodities markets...and more!
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Mutual funds have lost almost 3% of their value so far this year. The average investor has been losing money for years. But everyone remains remarkably bullish. No one seems to worry about the "fat tail" that must be out there somewhere - the possibility of a resumption of the bear market that began five years ago, or even a crash.
Actually, the bear market is not really a fat tail at all. That is to say, it is not a statistical anomaly. It is a likelihood. Somewhere in the main bulge of the bell curve stocks go down - in real terms - about as much as they go up. Having gone up for 25 years, more or less, since 1975...we should be looking at a long period when they go down. Well, they are going down. But the bear market rally that began in October 2002 has yet to be corrected. So most people think the long trend that began more than a quarter of a century ago is still in motion.
We don't know what stocks will do, but since so many people are so bullish...and since stocks are already at such high level...we see no profit in buying them. Instead, we wait for the bear market to bring them down to reasonable levels...or perhaps a fat tail crash to add a little excitement to our lives.
Even more exciting and amusing than stock prices are real estate prices. "It is as if you were paid to live in California," said a skeptic to the LA Times. Prices rose 22% last year. It meant that an average homeowner, with an average $400,000 house, added $88,000 to his net worth. He did this without lifting a finger. He must have felt as though he had gotten trapped in an elevator with a beautiful woman who was just released from prison. What luck!
And now he's come to see that he can make a lot more money buying houses than he can working for a living. House prices are soaring. The LA Times mentions a house offered for $980,000 that sold almost immediately for $1.5 million.
The Times story tells of a young woman who bought her first house with no money down and "interest only" payments. Only four years ago, less than 5% of new houses were purchased with interest only mortgages. Now, the total is nearly 50%. From the newspaper report, woman appeared to be headed towards a financial crisis. Homeownership, she believes, will bail her out. She told the paper that she intends to use her "equity" to pay down her credit card debt! More of the Times article:
"Last fall, Herron decided to take the plunge. With the first four places she found, she was outbid. Then a bottom unit in a fourplex became available, and she got it. She's still amazed.
"'I have $40,000 in student loans from my master's degree,' Herron said. 'I have high credit card debt. I'm a typical American. And yet they wanted to give me more debt to buy a house.'
She wonders sometimes if she'll end up in foreclosure, if the bank will take her beloved home away from her when she can no longer pay her bills. Maybe it was a mistake to give her this money; maybe it was a mistake for her to take it. But she wasn't about to protest.
"'If you're like me, you're so incredulous that anyone would give you any money whatsoever, you just close your eyes and sign the papers,' Herron said. 'I would have signed anything.'
Here, dear reader, we have the essential ingredient for a real fat tail. A crash in the stock market would be accompanied by the usual whining and gnashing of teeth. But a crash in the residential property market would be much worse. Households have come to rely on "equity" build-up to keep themselves solvent. What a pity if equity should every go negative...
[Ed. Note: As a subprime borrower, Herron would have had better luck signing her soul over to the devil...this "fool's paradise" of low interest rates can't last forever - and once rates spike up, the consequences will be more devastating than you can imagine. To find out how to survive (and profit) from the real estate bust, click here:
The Day the Buying Stopped
http://www.agora-inc.com/reports/DRI/WDRIF232
And more news, from our team at The Rude Awakening:
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Eric Fry, reporting from Manhattan...
"On December 16, 1998, an unknown stock analyst named Henry Blodget predicted that Amazon shares would soar to $400 over the ensuing 12 months. That very day, the stock jumped 46 points to $289. Less than one month later, Amazon shares did indeed hit $400..."
For the rest of this story, and for more market insights, see today's issue of The Rude Awakening:
Fading Goldman Sachs
http://dailyreckoning.com/RudeAwake/Articles/RA040505.html
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Bill Bonner, back in Jo'burg:
*** The Goldman Sachs report that predicted crude oil prices to hit over $100 a barrel has caused quite a stir...and not everyone is buying into the forecast.
The Dow Jones Newswires reports this morning, "Critics immediately questioned the conclusions, pointing to Goldman's huge energy trading operation and commodity-index business as reasons for the bank's analysts to talk the market up."
The article lists Kevin Kerr as one of those critics, and quotes him as saying, "'Clearly, the oil market is bullish in the long term. However, to suggest that it will happen in some mythical 'super spike' right around the corner is pure fantasy."
"Kerr suggested that Goldman's large position in energy derivatives may have prompted the report.
"'That may be more the motivation of this story and account for the timing of it as the oil prices were correcting a bit,' he said.
As you can imagine, this ruffled more than a few feathers at Goldman Sachs, and their spokesperson claimed, "Our equity research division is entirely independent and separate from our commodities trading division," said Goldman Sachs spokesman Ed Canaday. "Further, it is totally outrageous that someone would throw around accusations that we'd do something illegal."
Outrageous, indeed. Imagine two divisions of the same company talking to each other. What were we thinking?
[Ed. Note: Kevin Kerr is widely quoted in the financial press - and for good reason...his knack for trading and knowledge of the markets in amazing. His results speak for themselves...
Resource Trader Alert
http://www.agora-inc.com/reports/RTA/maniacF315
*** The unthinkable is making the papers: the French may vote against the European Union constitution. If they do, it will throw the entire EU into shock.
"The European Union is ungovernable," say American critics. Yes, we agree; that's what we like about it.
Meanwhile, Japan seems to have fallen back into its long slump. Prices are falling. Consumer spending is going down.
To many analysts this means that the dollar is a good buy. Its major competitors are growing less quickly. But neither of its main competitors need a cheaper currency just to balance their trade accounts, and they don't depend on foreign lending to balance its financial accounts.
None of the world's major paper currencies looks good to us. Sell them all. Gold, at $423, is below our current buying target. Buy.
*** "Yes, we're doing the usual idiotic things," said a South African colleague yesterday. There's a complicated system of affirmative action to try to get blacks into good positions. Almost all businesses have to employ a certain number of blacks. You get points depending on how 'disadvantaged' the person is. But if you can find a blind black male in a wheelchair, you've hit the jackpot. The trouble is, of course, that there aren't that many qualified black applicants. So, the good ones earn a lot of money. If you're black, you might earn, in dollars...say $60,000...for a management position. If you're white, you'll only get $40,000. This is done, of course, in the name of 'fairness'...creating a non-racial society."
What it really does is focus attention on race. The place becomes more "racial" than ever before...with everyone trying to figure out how to get around the race laws...or make a buck from them.
But whatever they're doing, it seems to be working. South Africa is booming. The restaurants are full...the traffic is heavy...there are merchants everywhere...and the GDP is growing.
*** "Granny accused of witchcraft escapes mob incited by her own son," says a headline in the Johannesburg Star today. The poor woman's shack in Soweto was surrounded by neighbors who seemed determined to burn it down - with her in it. They'd heard she had "bodies buried in there."
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The Daily Reckoning PRESENTS: Investors tend to steer clear of the commodities market, saying that it's just "too risky." But, as Jim Rogers points out, there has been more volatility in the NASDAQ in recent years than in any commodities index. Read on...
ASSET CLASS OF THE NEXT GENERATION
By Jim Rogers
Recently, at a party in New York, I mentioned that I had been talking to various groups in the U.S. and Europe about investment opportunities in commodities. Before I could get out one more word, a woman interrupted me. "Commodities!" she exclaimed, with the kind of incredulity in her voice that Manhattanites reserve for people moving to Los Angeles. "But my brother invested in pork bellies and lost his shirt. And he's an economist!"
Everyone seems to have a relative who took a beating in the commodities market, and this fact (or fiction) is considered sufficient reason that no sane person would ever risk playing around with such dangerous things. That this particular victim was also a professional economist makes the warning seem even more ominous. I, however, couldn't help laughing.
Billions of dollars are invested in commodities every day. Without the commodity futures markets, many of the things that you depend on in life, from that first cup of coffee in the morning to the aluminum in your storm door to the wool in your new suit, would be either scarce or nonexistent, and certainly more expensive.
To be sure, investing in anything has its risks. A lot of Ph.D.s in economics lost money in the dot-com debacle, too. (On New Year's Day in 2002, the Wall Street Journal published its annual survey of economists for the upcoming year. Although the economy had been sagging for almost a year, not one of the 55 economists thought that it was in for a serious decline. One hundred percent were wrong-and proof that Ph.D. economists are as prone to mob psychology as the rest of us.)
There are several other bromides out there for why "ordinary people" should not invest in commodities, and I want to lay these myths to rest, once and for all, so that we can get on with the more interesting business of how you can begin to make some money investing in the next-generation's asset class.
About that relative of yours who got wiped out...he was inexperienced. You can learn. Most likely, he was buying on thin margin-the minimum deposit a broker requires to take a position in a particular commodity-and when the market went against him he lost big-time.
Here's how it happens: Like stocks, commodities can be bought on margin. Unlike stocks, however, where by law you have to put up at least 50 percent of the price of the shares, the margins on commodities can be even lower than five percent: You can buy $100 worth of soybeans for $5. If soybeans go up to $105, you've doubled your money. Beautiful. But if soybeans go down $5, you're wiped out. Not so beautiful.
Experienced, smart speculators can make tons of money buying on margin. They also know that they can lose tons, too. But they can usually afford it. Your relative was in over his head. If he had bought $100 worth of soybeans in the same way that he can buy IBM-for $100 (or maybe even $50)-he would be happy when it goes up $5 and a lot less sad should it go down $5.
Whenever I mention commodities in public, someone always points out that we now live in a high-tech world where natural resources will never be as valuable as they were when we had a smokestack economy. But if you read your history you'll discover that technological advances are as old as history itself: The introduction of the sleek and beautiful Yankee clipper ship dazzled the world in the mid-nineteenth century, loaded with cargo, sailing down the trade winds at 20 knots and more, averaging more than 400 miles in 24 hours and able to make it from U.S. ports around Cape Horn to Hong Kong in 80 days; within a decade, the clippers had been replaced by the steamship, no faster but not dependent on wind power; and before long the next big thing in transport had taken over, the railroad, which, of course, was the original Internet- and prices in commodities still went up. In the twentieth century came electricity, the telephone, and radio (three more Internets) and then television (a fourth Internet). There was also the automobile, the airplane, the semiconductor-and in the midst of all of these truly revolutionary technological breakthroughs came periodic, multiyear commodity bull markets.
Even a revolutionary technological breakthrough in a particular commodity-related industry will not necessarily lower prices. For decades, drilling below 5,000 feet or offshore was virtually impossible. Then in the 1960s the Hughes diamond drill bit was invented and an explosion of technological advances in oil drilling and exploration followed. Drilling efficiency-and oil deposits- were available that had been unthinkable before this technological breakthrough. Soon there were wells 25,000 feet deep and offshore oil rigs multiplied around the world. Yet oil prices went up more than 1,000 percent in the 15-year period between 1965 and 1980. When the supply and demand in raw materials is seriously out of whack, the emergence of new technology will not necessarily restore the balance quickly. To be sure, changes in technology, for example, have made the economy less dependent on oil. But we still use plenty of it, and whenever there isn't enough prices will rise. Computers or robots may do amazing things, but they cannot find oil or copper where there is none or make sugar, cotton, coffee, or livestock grow faster than nature allows. We can put in orders all day long on our computers for lead, but all that Internet technology will be in vain if there are no new lead mines. Technology can neither feed us nor keep us warm, and the demand for commodities will never disappear.
Certainly, speculators who jump in and out of commodities can push up prices. And the dollar has been a pale remnant of itself- down against the euro almost 40 percent from the beginning of 2002 until the start of 2004 and at a three-year low against the Japanese yen. Since commodities are traded in dollars, a weak dollar will make prices appear higher. Crude oil rose 64 percent in dollars over that two-year period, but only 16 percent in euros.
But the dollar strengthened in the spring of 2004, and a funny thing happened: Commodity prices kept going up. The global recovery, particularly in Asia, was for real. We are now watching a fundamental structural shift in commodities markets, and it is called "supply"-and "China," a nation that will be consuming extraordinary supplies of all kinds of commodities for years to come.
And the dollar has nothing to do with either. Let me also remind you of the 1970s, when inflation in the United States was about 10 percent a year, the dollar wasn't buying anywhere near what it used to, and the economy was in a major recession-and commodity prices kept rising. We're talking another long-term bull market in commodities, and neither speculators nor a weak dollar can make that happen. Speculators can have a short-term effect only. For example, if they drive up the price of oil artificially, oil producers with excess supplies will gleefully dump their oil on the market driving the price back down. Both the dollar and speculation can have a marginal effect, but the market itself is bigger than they are.
You may say, "But my stock broker tells me that investing in commodities is risky."
Tell me again about all those Cisco shares you owned back in 2000. Or JDS Uniphase, or Global Crossing? So many risky stocks made the turning of the new millennium a not so happy time for many who watched their portfolios evaporate.
If you do your homework and remain rational and responsible, you can invest in commodities with perhaps less risk than playing the stock market. You don't need me to emphasize that investing in anything is a risky business. But let me point out something that you might not have realized: There has been more volatility in the NASDAQ in recent years than in any commodities index. Cisco, Yahoo!, and even Microsoft have been much more volatile than soybeans, sugar, or metals. Compared with the risk record of most tech stocks, commodities look safe enough to be part of any organization's "widows and orphans fund."
According to "Facts and Fantasies About Commodity Futures," the Yale study cited in the first chapter, the "high risk" of investing in commodities does not square with the facts. Comparing returns for stocks, commodities, and bonds between 1959 and 2004, the authors found that the average annual return on their commodi-ties index "has been comparable to the return on the SP500." The returns from commodities and the S&P 500 beat those from corporate bonds during that same period. They found that the volatility of the commodities futures under analysis was slightly below that of the stock in the S&P 500. They also found evidence that "equities have more downside risk relative to commodities."
How about buying shares in commodity-producing companies instead of buying commodities themselves? That's about as far as some financial advisers will go in the direction of commodities. But investing in commodity-producing companies can turn out to be an even riskier bet than sticking with buying the things outright. Supply and demand will move the price of copper, for instance, while the share prices of Phelps Dodge, the world's largest publicly traded copper company, can depend on such less predictable factors as the overall condition of the stock market, the company's balance sheet, its executive team, labor problems, environmental issues, and so on. Oil skyrocketed in the 1970s, but some oil stocks did not do that well. The Yale study found that investing in commodities companies is not necessarily a substitute for commodities futures. The authors found that from 1962 to 2003, "the cumulative performance of futures has been triple the cumulative performance of 'matching' equities".
And let me remind you of one more important difference between commodities and stocks: Commodities cannot go to zero, while shares in Enron can (and did).
Regards,
Jim Rogers
for The Daily Reckoning
Editor's Note: Jim Rogers helped found the Quantum Fund with George Soros. He has taught finance at Columbia University's business school and is a media commentator worldwide. He is the author of Adventure Capitalist and Investment Biker. He lives in New York City with his wife, Paige Parker, and their 18-month-old daughter, who is learning Chinese and owns commodities but doesn't own stocks or bonds.
The essay you just read was taken from Jim's recently released third book, Hot Commodities. You can order your copy at The Daily Reckoning's bookstore, at 24% off the regular price. See here:
Hot Commodities
http://www.invest-store.com/cgi-bin/dailyreckoning-bin/moreinfo.cgi?item=2578140
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