Understanding financial markets: commodities as an investment option


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Text comes from: Rohstoffe der attraktivste Markt der Welt. Wie jeder von Öl, Kaffee und Co. profitieren kann (2016) Die Wallstreet ist auch nur eine Straße. Lektionen eines Investment-Rebellen (2013) by Jim Rogers, published by Münchener Verlagsgruppe (MVG), Reprints by friendly permission of the publisher.
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Raw materials are not respected. Too many so-called smart investors believe that they are diversified enough by the time they invest money in stocks, bonds, and real estate. But that's a mistake.

Understanding financial markets: commodities as an investment option

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Jim Rogers is an American hedge fund manager and writer.

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How to gain more experience with raw materials

For the most experienced investors, in addition to stocks, bonds and real estate, foreign exchange or lumber may also be considered. But they rarely think of raw materials - if at all. It makes little sense to ignore an entire class of investment instruments - especially if they have performed well over the long term. The truth is very much at odds with all the talk about how risky, volatile, complex and downright dangerous investments in commodities are supposed to be. Successful investors look for opportunities to buy valuable assets cheaply and hold them for the long term, regardless of the market situation. So what should you do if you are new to raw materials? All you have to do is do your homework, and there is no better motivation for quick learning than the prospect of financial gain.

I would like to tell you a story about an investor who didn't know the slightest thing about commodities at the beginning (which was also true for all other investments) and who later achieved great success. On a whim, I took a vacation job on Wall Street in 1964. All I knew about Wall Street then was that it was somewhere in New York and that something terrible had happened there in 1929. In all honesty, I didn't even know the difference between a stock and a bond. I knew, however, that you could make money on Wall Street. And I wanted to make money to buy my freedom because I was a poor boy from Demopolis, Alabama who had been lucky enough to go to Yale to study. Although I knew next to nothing about the world of finance, I had always been very interested in history and current events. It was a revelation to me when I learned that I could make money on Wall Street knowing that a revolution in Chile would drive the price of copper up.

Review of history

My lucky streak continued. I got a scholarship to Oxford, where I studied political science, philosophy and economics. I also began using what I learned from my Wall Street summer job and investing the money from my scholarship before I had to turn it over to the purser at Balliol College. After my stay in Oxford, I served a short time in the army, where I distinguished myself above all by investing the site commander's money in shares and thus generating a nice return. After that I went back to New York and started my career in high finance in 1968. I had $ 600 in my pocket. My arrival on Wall Street, it turned out, coincided with the final twitches of the stock market bull market that had begun after World War II and lasted for more than two decades. But who knew then that 1968 was a turning point in the stock market? I definitely don't. I was too busy getting used to it to be able to keep track of the big picture. And I still had a lot to learn. My inexperience should prove to be a huge asset. After learning the basic rule of investing - buy something of value cheaply - I began scouring the markets, all markets, for undervalued assets. I explored every opportunity that presented itself, and objectively speaking, there was hardly a stock at the time that was worth a second look.

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That made me very different from my peers, who found it difficult to betray the stock market that had been so good to them for decades. As the bear market stretched into the early 70s, I spotted many good opportunities in the commodities space. I no longer know exactly when I started a thorough study of the commodity markets. However, a look at my bookshelves shows that I bought my first CRB Commodity Yearbook in 1971. This commodity traders bible is published annually, and I have had all of the editions since 1971. I can still remember examining the charts of various commodities. If there was a sharp increase, I would analyze why the price of this commodity had increased so quickly. I studied supply and demand trends. I looked for clues to obsolete production facilities or new finds of metal deposits. I checked the weather report: a cold winter meant higher heating oil and natural gas prices; a warm Florida winter meant orange juice would become cheaper next year. And my constant interest in history and politics reminded me that what was happening in the rest of the world would affect prices on Wall Street. I knew that during the American Civil War in the 1860s, cotton exports to England stalled, which drove the price so high that the English were soon planting cotton anywhere they could scratch the ground. This knowledge was extremely helpful to me in understanding why commodity prices around the world rose again more than 100 years later.

Why raw materials are the better investment

This self-study in the field of raw materials was years ago, and I don't remember all the details. However, I remember clearly and with a certain sadness that I was in the middle of the first bull market of my life. It happened in the raw materials sector, and I benefited from that development for a decade. As you can see, stocks aren't the only area where bulls and bears exist.

These early commodity investing experiences also played a role in my success as co-manager of an offshore hedge fund, studying the global flows of capital, commodities, goods and information. In 1980, at the age of 37, I was able to retire. The stock market, on the other hand, had been a disaster for most of the time. In 1966 the Dow Jones closed at 995,15 points. In 1982 it stood at 800 points - a full 20 percent loss after 16 years. (And I didn't even factor in the effect of inflation, which was worse than ever in US history in those 16 years.) Americans withdrew their money from equity funds. In 1979, a now famous Business Week cover proclaimed, “Stocks are dead!” I disagreed with that. When I said publicly in 1982 that the bear market in stocks was over and that it was probably time to start investing in stocks again, I was thought crazy. That was a good sign. I had already realized then that I had made most of my money by investing where no one else was, and the stock market was far too pessimistic at the time. It was time to take a different path. When the Dow rose more than 1983 percent to 50 points in a single year in 1.200, experts began to warn: “Better sell. This development is crazy. It's going too fast and too far. ”And then, of course, there was one of the biggest bull markets in history and the Dow topped the 1999 mark in 11.000. The Dow and the S&P index increased more than tenfold in the 80s and 90s. The Nasdaq was about 2000 times higher in 25 than it was in 1980. But it couldn't go on forever. That never happens in the markets. Eighteen years is a long time on the stock market - and indeed the average length of significant bull markets in stocks and commodities.

As early as 1998 I began to notice that many stocks were falling in price. I was doing a weekly stock market show on CNBC at the time and I started talking about commodity investments; also about how the rapidly growing Chinese economy would drive up the demand for raw materials - everyone looked at me like I was crazy. Yet again. I published some Article about commodities in the Wall Street Journal and Barron's, and when reporters called me to get my opinion on the markets and the state of the economy, I got the conversation down to commodities. Nobody listened to me. After all, the Dow and Nasdaq had climbed to heights no one dared dream of. Otherwise sensible and hard-working Americans had treadmills with current stock prices installed on their PCs. Less sensible Americans had quit their jobs to make a living as day traders. In 1999 three books were published by alleged stock experts, entitled: Dow 36.000, Dow 40.000 and The Dow 100.000. In the same year, more than a third of all covers for Business Week - and five 100-page special inserts - dealt with the “Internet revolution”. Number 24 on Fortune's "100 Best Places to Work" list was Enron, which had soared to $ 90 that year. The Wall Street Journal and the New York Times published clever articles that said what was happening in the stock market was not the development of a classic "speculative bubble". “It's different this time,” was the statement. It wasn't just a strange new moment in economic history. It was not just a “new economy”, but “the new economy!” Millions of Americans took part in the stock market, and capital inflows from investment funds shot through the roof. A Gallup poll at the time found that 60 percent of Americans were involved in one way or another in the stock market. If you walked into a bar or a golf club's clubhouse anywhere in America, everyone saw CNBC! And these people said I was crazy! If someone says in connection with investments that this time everything will be different, then I'll get my money together and run away.

The new economy was contrary to common sense

In my opinion, the only "new" thing about the new economy was that companies were worth trillions of dollars on the stock market without being asked to make a profit. Obviously this was against common sense, not to mention economics and history. Corporate earnings would never justify these stock prices. There was certainly nothing new under the sun when it came to losing your money - or your sanity - in a general stock market hysteria. When I see how people cannot put their money fast enough into everything that is currently considered hot speculation, then I think of Bernard Baruch, the legendary stockbroker and advisor to several presidents. One day, during the stock market hysteria of the late 20s, Baruch had his shoes cleaned and the shoe shiner began to give him stock tips. When his shoes shone again, Baruch went back to his office - and sold all of his shares. In mid-1998 I had my own Bernard Baruch experience. Most people were blinded by the astonishing, never-ending rise in prices of some of the flagship technology stocks. Cisco, Nortel and JDS Uniphase kept rising, and Microsoft's course never showed any weakness. I noticed at the time that most other stocks were actually losing price. My interest shifted from the stock market back to my CRB commodity yearbooks and other sources because I wanted to see what was going on in the markets for agricultural goods, energy, grains, metals, live cattle, and other precious things in life. It turned out to be incredibly under-rated. Adjusted for inflation, raw material prices actually approached a level that had not been seen since the global economic crisis of the 30s! No sooner had I immersed myself in commodities than the world's largest brokerage firm, Merrill Lynch, Pierce, Fenner & Smith, announced that they would be pulling out of the commodities business. In the 70s, Merrill Lynch had made huge profits in commodities trading. Now it only contributed a tiny fraction to the company's turnover.

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I had to grin and couldn't stop. If everyone, including the wise men (and now women) at Merrill Lynch, said that no American in their power of mind would want to buy more commodities, then it was really time for that American to buy commodities - at bargain prices. My opinion was strengthened when some other commodity optimists, who had read my articles or heard me talk about commodities on television, offered me to become their partner in commodities trading. I wasn't interested. I had retired from professional trading 20 years earlier. I was also about to embark on a three-year trip around the world. I would also be on the road at the turn of the millennium. It would have been logically impossible to observe the movements in the commodity markets while I was traveling in Africa, Siberia or China. Still, I didn't want to miss the early stages of a new bull market that few others had noticed. So I decided to start a commodity index fund. For years, studies have shown that the most effective and profitable investments are made with index funds, which are named because they are based on major indices such as the S&P 500, Russel-2.000 or Russell1.000. So you don't try to outperform the index, but buy a fund that puts together a basket of shares and guarantees that it will perform exactly as the index under all circumstances. You pay in your money, and the fund buys stocks of the 500 big companies that make up the S&P 500, the 2.000 small caps, or the 1.000 growth stocks in the two Russell indices - and that's it. Your investment flies on autopilot. There are no ongoing stock switching fees, high administrative costs, and no decisions to make. Your success does not depend on the genius of a fund manager, but on market developments. The S&P goes up or down - and so does the fund. There is ample evidence that such investments outperform most actively managed funds.

Act on autopilot

Because I was confident that commodity prices would rise across the board, such an autopilot was exactly what I was looking for. I knew four commodity indices and was checking which of them to license. The best known at the time was the CRB Futures Index, which was maintained by the same people who published the yearbook that gave me my first experience with commodities. Today the official name is Reuters-CRB Futures Price Index. When examining the CRB index, I quickly came across a significant problem: its 17 components are all equally weighted. This means that the crude oil has the same meaning as orange juice. I don't know about you, but oil plays a far more important role in my life than orange juice. Then I spoke to an old college friend who now runs the Wall Street Journal about the Dow Jones indices. "I want to get a license on your commodity index," I said, and he looked at me as if I had lost my mind: "We don't have a commodity index." He was amazed when I informed him that something like this was in his every day Newspaper is published. Another proof of the investors' disregard for commodities, because not even the editor of the leading business newspaper in the USA bothered. I quickly realized that the Dow Jones Commodities Index had not been revised since at least the 60s. So I visited another old friend at Reuters, the international news agency whose index had been around for years. Even this friend had no idea that there was such a thing at his company. But I quickly discovered that the Reuters commodity index had not been revised since the 30s. (In 1999 Dow Jones partnered with AIG to create a revised index, the Dow Jones-AIG Commodity Index, which I believe also has major weaknesses. Reuters, along with the Commodity Research Bureau, has the Reuters-CRB Futures Price Index designed.)

Then I turned to Goldman Sachs, because the company was promoting its own commodity index, designed in 1992. But I immediately saw a major disadvantage in the Goldman Sachs Commodity Index (GSCI): Oil and gas are weighted there at 65 percent. As important as oil and other energetic commodities are, I don't think they should make up almost two thirds of an index. And if they were that important, then you should probably buy oil and gas futures right away. The weighting of the index components in the GSCI changes depending on the price development, and therefore there are extreme changes every few years. Anyone who invests in the GSCI today does not know what they will have in 3 years; not even Goldman Sachs. In my opinion, the GSCI is not a useful index. I want consistency, stability and transparency. So I looked for information on the Journal of Commerce's Commodities Index. It has also existed for many years - and you can tell from it. In addition to the usual raw materials, it also contains hides and sebum. We all wear shoes and blow out our birthday candles once a year, but neither hide nor tallow is traded on any stock exchange today, so fixing the price of such materials would be problematic. Rice, on the other hand, is traded on stock exchanges. Half the world eats rice every day, and yet none of the existing indices contained this commodity. All of them were too tailored to America. So I came to the conclusion that the well-balanced and internationally oriented raw material index I was looking for didn't even exist. It was further proof that no one cared about raw materials. This outrageous contempt for an entire asset class on the verge of soaring reminded me of the stocks-are-dead attitude of the early 80s - when the Dow was just beginning its staggering 800 to 11.000 rise. It was now clear to me that if I wanted to invest in commodities, I would have to design an index and a fund myself.

How to design your own fund

I did that too. The Rogers Raw Materials Index Fund started operations on August 1, 1998 and is based on the Rogers International Commodities Index (RICI). This contains 36 commodities that keep the global economy going, and is an effective measure of commodity price developments not only in the US, but worldwide. The selection and weighting of the fund components are revised annually; the weighting for the following year is always determined in December. So far the changes have been minimal. (A list of the RICI components can be found in the appendix to this book.) On January 1, 1999, I began my journey around the world. In three years I drove 152.000 miles through 116 countries. On the way, I heralded the new millennium by marrying my travel companion Paige Parker on January 1, 2000. Many asked me how I would manage my money while traveling in remote regions of Siberia, China, and Africa. When I told them that part of my money was invested in a commodity index fund, they responded with amazement and also a little concern for my financial well-being and mental health. After talking so much about the bright future of commodity futures, prices fell. In fact, by late 1998, the RICI had lost 11,14 percent of its value. But I was happy. I had done my homework and believed that the bull market was over. By 1998, 60 percent of America's stocks were down, and that pattern continued in 1999. The boom on the commodity markets had already started. (It later emerged that we were only a few weeks early to hit rock bottom.)

When Paige and I returned from our trip to a September 11th America, the index was up 80 percent. (In October 2004 it was 190 percent.) During our absence, the dot-com bubble burst. Some people said I was lucky not to have suffered this pain. I tried to answer kindly. After all, I was old enough to know that if you move away from the herd, you will always be criticized. One is even insulted and called "crazy". But for an investor, that's a positive thing: when I got away from the herd, I almost always made a lot of money. If you want to find new ways, you have to leave the old way. I'd talked about China and raw materials enough times, and everyone had called me crazy. However, if you make money against the majority opinion, you are no longer crazy. You were just "lucky".

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The relationship between supply and demand

In the early 70s, when the days of cheap natural gas and oil were numbered, I sat with one of the few hedge fund managers there were at the time. He was a graduate of Harvard College and Harvard Business School. I explained to him that supplies of natural gas and oil were running out, that gas reserves were low and prices were ridiculously low, and advised him to buy as many stocks of oil, gas and related companies as he could get. The man disregarded my advice - even though prices were already rising then. In 1973 war broke out in the Middle East and oil prices shot up. The Arabs boycotted the United States that supported Israel. Oil prices continued to rise. Then I met my friend, the hedge fund manager. "You were very lucky," he said. Didn't I tell him long before the war and the boycott that oil prices would surely rise because supplies were already low and no new reserves were being developed? I reminded him that OPEC was founded in 1960 to raise oil prices. For the next ten years, the oil ministers of the OPEC countries met annually and solemnly raised prices. But the market ignored this and prices remained relatively low.

But by the 70s the balance between supply and demand had shifted in favor of oil, and prices had to go up, whatever OPEC would do. The high oil prices had nothing to do with the conflict between Israel and the Arabs, and as if to prove it, the OPEC countries ended their boycott less than four months later. The Saudis did not let politics stop them from making a lot of money from these record high oil prices. Prices remained high for years after the war and boycott (and amazingly even after 1978, when supply exceeded demand). I've learned that if you do your homework, you will definitely be very “lucky”, realize that supply and demand are totally out of whack, and then invest accordingly. This, my friends, is one such opportunity.


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