COMMODITIES GET THE LIQUIDITY
Let me start with a whimsical and absurd story to illustrate a point.
In the mid 60’s a friend of mine became the manager of a band in Berkeley, California. The previous manager was fired because he did not get paid by a concert promoter for concerts that the band had performed. Immediately before he was fired, he had hatched a plan to get the money the band was due. The plan was to give the promoter a soft drink laced with a drug. To quote the former manager: “When he has the experience of the drug he will see the correctness of giving us our pay.” The scheme was unsuccessful when the previous manager was unable to convince the promoter to take a soft drink from him.
There are a couple of messages in this wacky little story. First, the previous manager was out of touch with reality. The second message is that markets are like concert promoters, no market is going to take a soft drink [or anything else] from you, and thus change its behavior to the way you would like to see it.
But here is the good news. If you study them, most markets will do something else for you; they will tell you what they are going to do. It just takes a deep understanding of markets to allow you to gauge the probabilities of the occurrence of a specific event.
In our opinion, today’s markets are saying loud and clear, these commodities are rising and they will continue to rise for some time.
WHY ARE COMMODITIES RISING IN PRICE?
It’s simple — demand for them is rising and supply is often uncertain.
The demand is primarily from growing countries for infrastructure and for energy to make their economies grow. Their economies are growing and thus their demand for commodities is continuing.
I don’t care which country it is; it must build infrastructure like roads, bridges, ports, railroads, sea and air transportation, dams, and communications infrastructure. It must supply utilities like heat, electricity and water. It must dispose of waste and deliver raw materials and other supplies.
I live in Los Angeles, a city famed for image and glitz. Image and glitz have their place, but the underlying structure of every economy and every major industry is access to infrastructure that allows them to execute their business plan, and thus to make money. Image and glitz come at a later stage, and are part of marketing and selling. They are not part of logistics and production.
Infrastructure takes minerals; copper, lead, zinc, steel, cement, coal, oil, natural gas, iron ore and a great many other chemical and mineral components, as well as a great deal of engineering expertise, in order to be created. Unsurprisingly, these goods are in demand and will be in demand for a long time to come.
Minerals, energy, chemicals and engineering services may be prosaic, but today they are very profitable. The growth of profits from these areas will far exceed the growth of profits in other segments of the world economy for some years to come. After a long period of unwillingness to recognize the obvious, investors are now starting to realize that the demand for commodities will continue.
DEMAND COMES IN MANY FORMS
Let us take the example of gold. Gold demand comes from those desiring to process it for jewelry or industrial purposes and from those who would like to hoard it for speculation or investment.
Governments hold gold to increase their credibility and economic power and to diversify their holdings from paper money.
Investors, especially professional investors, are holding more gold than ever.
A big new source of demand is from ETF’s or exchange traded funds. ETF’s have provided global investors with a new mechanism for holding gold.
The old methods; Coins are cumbersome and many custodians don’t want to deal with them. Gold shares work for professional investors but many investors do not have the capability to analyze them as they are difficult to understand and speculative in that thy must raise large amount of money to build their mining infrastructure. Mining in its basic nature is uncertain and mining companies do not lend themselves to easy analysis. This is the reason we prefer royalty companies.
But back to the point, ETF’s allow investors to own gold bullion through a financial mechanism and one that is highly liquid and traded on major exchanges in New York, London, Paris, Australia and Johannesburg. Moreover, they may soon be traded in India, possibly Hong Kong and other locations.
A year ago ETF’s owned 170 tons of gold and now hold about 414 tons. That is a 170% increase in one year. Today ETF’s are the 13th largest holder of gold. At the rate that they are growing they will continue to move up and in the not too distant future they will be one of the largest holders of gold on earth.
We have been beating this drum for years but more growth in the global economy means more demand for commodities. Everyone seems to be belatedly catching on.
BELOW IS THE CHART OF THE U.S. GOLD ETF
The stocks we own are not recommended for purchase at today’s prices and for information only. We may buy and sell these stocks at anytime and will not notify anyone of our moves.
The big opportunity is in commodities and most of our investments are in stocks of companies involved in commodities in some way: as producers, shippers, suppliers of equipment to the producers or shippers, processors, distributors or marketers of the commodities.
For decades one of the main indicators I have watched to help determine the strength of the global economy, is the commodities research bureau index and especially the basic materials component of the index. These indicators have been signaling strong global economic growth for some time. Basic materials demand continues to project economic growth too. Don’t look now but the basic materials prices are red hot. Global economic growth is doing very well. I see no slow down in 2006.
WHAT WE OWN
WE OWN COMPANIES THAT PRODUCE COMMODITIES AND THOSE COMPANIES WHO SUPPLY SERVICES TO COMMODITY PRODUCERS
We have not forgotten our thesis that oil and natural gas may peak out in the seasonally cold winter season, and fall back in spring and summer as the weather warms.
This year, there are other considerations as well. First, we believe the U.S. elections are bearish for U.S. natural gas producers and oil producers. Talk of windfall profits taxes and other unwise moves have already begun to circulate. We would not be surprised to see politicians create a lot of bad publicity for US oil companies.
Foreign oil companies still look good to us, as do U.S. oil service companies. If Iran develops into a bigger problem, then energy prices could rise through the seasonally weak summer. So we are uncertain about energy prices but we have a solution.
We have sold a lot of our U.S. energy production companies and we are continuing to hold the oil service companies who sell services to the energy industry. We hold them because no matter if energy prices rise or fall their profits will rise rapidly for several years. They have firm contracts for their products and services that make their earnings highly visible.
We own gold mining companies including: GoldCorp, Glamis Gold, Tan Range, Royal Gold and others.
We own silver mining companies including: Silver Wheaton and Coeur D’Alene among others.
We own engineering companies who provide services to the mining and energy industries.
We own oil service stocks.
We own coal and alternative energy production companies including: Consol Energy, Rentek Inc., Intercontinental Exchange, and others.
BELOW IS A CHART OF THE COMMODITIES RESEARCH BUREAU INDEX
WE OWN FOREIGN STOCKS AND US STOCKS
This is a picture of what we currently hold, however, we may add or remove any of these stocks from our portfolio depending on many variables. Also, we have owned many of these stocks for some time and do not recommend buying them now.
Hong Kong- We own major real estate owners and developers who have large holdings of properties in Hong Kong and are adding to their holdings in mainland China. When we bought these companies, they were selling below financial book value and at a tiny fraction of the cost to replace the real estate holdings. They also pay dividends. Currently, they are building high-end shopping centers in China.
Japan- We own a broad cross section of the economy focusing mainly on financial institutions who will get the business form the continuing boom in demand for the Japanese
Yen and Japanese shares. We hold Sumitomo Mitsui Bank, and iShares Japan index.
US- We own a cross section of companies who benefit from energy, mining, medical and technology trends.
India- We own companies providing energy from sugar cane [ethanol] and oil exploration and oil transportation to this very fast growing country. By the way, we expect GDP growth of about 7 1/2 % in 2006 and above 8% in 2007 for India. This means corporate profits will be way up.
BELOW IS A CHART OF THE JAPANESE MARKET EFT
We own British Pounds and Australian dollars for our clients’ cash balances. We realize that the U.S. dollar has rallied for the last few days and some say it will continue. We do not agree. It may take a month or even three, but in the not too distant future the dollar will once again begin to decline.
With a long term view it is hard to be bullish on the U.S. dollar, so we continue to hold our foreign currencies, so that we will be prepared when the dollar slide begins. It may happen tomorrow or in several months. Because we own stocks in several countries we also own their currencies in which the stocks are denominated, including Euros, Canadian Dollars, Hong Kong Dollars, Japanese Yen and Indian Rupees.
ECONOMICS MAY CAUSE DROWSINESS
I realize I have not mentioned economics much in this letter. Hopefully, this has caused some of you to avoid falling asleep during the reading of this email. I will address the economics of the countries in which are invested in the next missive. Thanks for listening.
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You can also read Monty Guild’s past periodic market and economic commentary articles by going to the Commentary Archive on our web site www.guildinvestment.com.
Monty Guild is Chairman and CEO of Guild Investment Management, Inc., a registered investment advisor. All material presented herein is believed to be reliable. Investment recommendations and opinions expressed in these reports may change without prior notice.