Commodities: The One Profit Play Investors Can't Afford to Ignore

Money Morning Staff Reports

Commodities investing was once limited to the super-wealthy. But not anymore. In the face of almost-certain inflation – and with soaring growth in such fast-growing markets as China already driving up global prices for food, oil and gold – virtually every investor needs to have some money invested in commodities, says Peter Krauth, a longtime commodities-investing expert who is also the editor of the Global Resource Alert service.

“Every investor needs to have a financial exposure to commodities,” Krauth says. “For one thing, although commodities have been in a bull market since 2000, bull markets in commodities tend to last a long time. This one, in fact, is likely to last as long as 17-20 years. That means we’re only nine years in – with a decade or more left. Then there’s the tremendous growth we’re seeing abroad. There’s still a major opportunity for investors to profit from these trends.”

Krauth – a contributing editor to Money Morning – sat down recently with Money Morning Executive Editor William Patalon III to talk in detail about commodities investing. Here are the highlights of that interview:

Money Morning (Q):  For years, such “alternative investments” as gold and natural resources were viewed as the exclusive domain of the wealthy. But you believe that almost every investor needs to have investments in such natural-resource investments as gold, silver and energy.  What do investments in these “hard assets” give you that a similar-sized investment in stocks may not?

Peter Krauth: Protection from inflation is a huge benefit.  Inflation is a subtle-yet-menacing tax that government imposes on us by debasing the value of our cash and fixed-income investments.  They do this by printing money – lots of it. Just look at what [U.S. Federal Reserve Chairman Ben S.] Bernanke is saying about the central bank’s so-called “exit strategy” right now.

(Q): Can you name some of the specific investments in this category, and list some of their specific benefits?

Krauth: Specific investments would include gold, silver, oil, and copper, to name a few. All of these are valuable – and possess an actual value – which means that they will not go to zero.  They’re also assets that are never someone else’s liability.  Since they are priced in U.S. dollars, as the dollar loses value through inflation, you need more dollars to buy the same quantity (not to mention increasing demand).  That sounds like good protection to me.

(Q): What are some of the strong global trends – worldwide infrastructure development being one, we know – that figure to drive up demand for these natural resources?

Krauth: Voracious demand from large emerging economies that are growing and modernizing.  Just the two countries of China and India are home to about one of every three humans on earth. Their disposable incomes are improving, so they want to eat more meat, have the latest electronic gadgets and condos, and drive new cars.

(Q): What geographic parts of the world are the strongest providers of these resources?

Krauth: Some of the biggest providers of natural resources are Canada, Australia, Latin America, Africa and Russia.

(Q): What countries or regions are the biggest users of these resources?

Krauth: Traditionally, the biggest users were in North America and Western Europe, but China, India, and much of the rest of Asia are catching up on a total usage basis.  Plus, there’s a lot more demand to come, since most of these countries are still way below the West on a per-capita consumption basis.

(Q): We’ve heard that China is working very hard and using the global financial crisis to lock up captive supplies of many key resources. Does this figure to drive up the prices of some of these already-scarce resources?

Krauth: No question in my mind.  And China is using every means at its disposal.  What would you do with a $2 trillion foreign reserve?  Remember, at least $763 billion of this is directly placed in U.S. debt.  It makes perfect sense to be trading an asset I’ve got too much of, and whose value is depleting [U.S. dollars], for assets I need more of [commodities], especially when they’re on sale.  China’s imports of refined copper in April of this year at $2 a pound were 148% above April 2008 levels, when copper was trading at $4 per pound.

(Q): Is this rising demand by global players a trend the typical individual investor can profit from? Can they profit directly, by investing in the assets themselves? Or can they profit indirectly, by investing in the markets where the demand is strongest, figuring that these markets will have stronger growth than, say, the United States?

Krauth: I believe that investors can profit both ways – directly and indirectly.  The more direct approach is to buy the stocks of companies that produce these commodities – as the price goes up, so do the companies’ profits.  Investors can also consider investing in the end-users of these products, but then they must make a geographical bet.  Meanwhile, commodities get sold to the highest bidder, no matter where those bidders happen to be.

(Q): What’s the basic premise behind your new Global Resource Alert trading service? What’s the strategy that you employ?

Krauth: What we’re doing is seeking out the best opportunities for subscribers across all commodity sectors.  That includes precious metals, base metals, energy, alternative energy, and even agriculture.  I look for prospects in a sector that has fallen out of favor, yet has great fundamentals.  I also ride sectors that my research demonstrates are in a sustainable, upward trend.

(Q): What types of investments do you highlight? Stocks? Exchange-traded funds (ETFs)? Any others?

Krauth: We trade mostly small- and mid-cap stocks, as well as ETFs and ETNs [exchange-traded notes].  There’s enough opportunity there to benefit from all the underlying trends.

(Q): What are the hottest sectors you see at play right now?

Krauth: Right now, I see precious metals and agriculture as the most attractive.  Both will be benefiting from growing demand and inflation concerns.  Remember, financial markets look forward.

(Q): You’ve talked about the “commodities supercycle,” as well as the “Secular Cycle.” What, exactly, are these and how can investors benefit?

Krauth: My recent Money Morning article on the Secular Cycle should be read by all serious long-term investors. Essentially, if you look at market behavior over, say, 100 years, there are distinct, alternating cycles that typically last 17-20 years.  When general stocks are in a bear market, commodities are in a bull market, and vice versa.  But you can’t see this without stepping way back and visualizing the long-term view.  Right now, we’re clearly in a long-term cycle, where commodities should continue to do well.

(Q): What are the factors at play?

Krauth: You see, major under-investment between 1980 and 1999 in commodities has set us up for a long-term bull market in hard assets.  China and the Asian Tigers have awakened, and now they’re very hungry.  I want to own the commodity producers that will feed them.

(Q): What effect will this growing global demand for commodities have on the U.S. economy? The U.S. dollar?

Krauth: The U.S. economy is in for a tough slog.  Plus, American consumers will have to compete with others to buy commodities on world markets at ever-increasing prices.  Between August 2008 and May of this year, the U.S. Federal Reserve doubled the money supply.  That’s about a 110% growth rate in nine months – an astounding run-up. Over the past 95 years – the Fed was established in 1913 – the annual average has been only about 6% annually.  We’ve lost 95% of the dollar’s purchasing power since then.  This reckless behavior will lead to major inflation once again.  This isn’t new.  Just look at what happened during the early 1920s in Germany’s Weimar Republic [See accompanying chart].

(Q): Looking down the road, what are one or two of the most interesting new trends that you see emerging in the future?

Krauth: Gold has steadily gained popularity with individual and institutional investors. That’s a trend that can’t be ignored – but is also relatively simple to invest in. Today, the SPDR Gold Trust (NYSE: GLD) – an exchange-traded fund that invests in gold bullion – is the second-largest ETF in the world.  With 1,120 metric tons of gold, GLD ranks as the sixth-largest holder of bullion on the planet.  There are similar ETFs for silver, and for other commodities, such as oil and agricultural products.

(Q): What will be the catalysts behind those new trends?

Krauth: Putting gold into the hands of the masses is quickly making it the new “equalizer.”  I expect to see more and more ETFs, perhaps some new ones for base metals will emerge.  But, for serious profits, investors need to look at the producers of these assets, since they benefit from leveraged profits as prices rise.

[Editor's Note: If you're new to the commodities-investing arena, and are uncertain about the landscape - or even if you're an "old hand" at natural-resource stocks, but want some insights into the new profit plays and new players - consider hiring a guide: Money Morning Contributing Editor Peter Krauth, a recognized expert in metals, mining and energy stocks, is also the editor of the Global Resource Alert trading service, which ferrets out companies poised to profit from the so-called "Secular Bull Market" in commodities. A former portfolio advisor, Krauth continues to work out of resource-rich Canada, which keeps him close to most of the companies he researches. Against the growing global financial malaise, Krauth says that commodities are among the most-profitable and least-risky investments available, and notes that this may well be the most powerful bull market for commodities we'll see in our lifetimes. He makes a strong case. To read more about his strategies, and the sector plays he likes the most, please click here. ]

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