How to Play Commodities

Q: How far can the price of oil go? What are good ways to play the commodities markets over the next 5 years?

A: I don't have any problem with the idea of $200 oil any more than I do $2000 gold. The only question is "When"? That will depend on supply, demand and the dollar. Hard to forecast the exact direction of all the variables for any point in time. But, I think it is safe to say that supply for raw materials / commodities is hard to quickly expand, due to the infrastructure required. So, any increase in demand due to an expanding global economy, will drive prices higher.

The dollar may or may not get much weaker. At some point, the other countries will defend their own currency by either buying dollars, dropping their interest rates, or both. Emerging markets dependent on higher employment rates to keep their citizens happy, cannot allow Americans to take back jobs due to a cheap dollar. So, there is a practical limit to dollar weakness, at least in the short and mid-term (one month to five years).

But we are seeing the beginning of a correction to commodities right now, so I would wait to make a move. The Fed's defense of our banking system and economy are supportive of the dollar. This action will move money from the defensive position of precious metals and oil back to the stock market, which will deflate prices over the next couple months (or however long the rally runs). I would be prepared to move money into commodities gradually, over a long time horizon.

As for vehicles, I have always like FNARX, which is Fidelity's natural resource fund. It has done very well. I am in GGN, but it has been a bit disappointing. DBA is a good way to play the ag market. OIH and IXC are a good way to play the oil market. And, of course, I am in love with VGPMX for precious metals and have been for more than five years. But it is closed now.

Gold: An Investment for Decades to Come

Jake, Thanks for the newsletter. I am pretty much in sync with this writer's perspectives.

My thoughts on gold have not changed much in several years. I think it is a store of wealth and will do better in times of inflation and dollar devaluation (which mostly run together). Even if gold stays steady and goes no where against other national currencies, as long as the dollar goes down, gold will go up by the same amount, just as other dollar denominated commodities do, like oil.

Additionally, there is the risk premium put on gold for an uncertain world and, probably most importantly, the future demand that will come from Asia. Gold is favored in Asia throughout history, so that is not likely to change soon. As Asians have more disposable income, they will buy more gold, and will increase global demand. Also, the Asian (and Middle Eastern) economies will grow rapidly over the next 20 years (10% a year on average, perhaps) and will probably need 10% more a year of gold reserves to back their currency, and maybe more as they lose confidence in the dollar and shift their reserves towards gold and sell dollar instruments like US Treasuries.

So, for many reasons, I think gold is good for many years. The only reason it did poorly the past 30 years was that the dollar took the role of global reserve currency and the global central banks, especially the US and Europe, sold off their gold reserves adding supply and dropping demand. I don't think the dollar will get that "Reserve Currency" role back anytime soon after all the losses incurred by governments and dollar investors around the world the past couple years.

As you know, I own gold through VGPMX, GGN and best of all, BEARX. Even though BEARX is a bear market fund, it held its own even in the years when stocks were in bull mode because of its gold holdings. It is half shorts and half a gold / precious metals fund, with lots of junior gold producers that will do very well if gold prices continue higher.

Hope this helps.

Why Invest in Gold and Precious Metals?

Brian, Your thoughts on Gold/Precious Metals.
I recently bought some Freeport Gold & Copper FCX and it is up 15% in one week. The price of gold is $745+-. Many analysts are saying that Gold will double in 2 years. Should I buy more? What percentage do you have in Gold/Precious Metals?

Jake, Even though I really like FCX and have owned it in the past (going back to 1999 when it was Freeport-McMoran C&G), it is not a gold pure play. It is as much copper as gold (and other minerals), but it is a very good China play since most of its mines are in Indonesia and an “anti-dollar” which is the key value of gold right now, as the dollar dives. Another good stock very similar to FCX is BHP.

I have been using funds to create a core position in precious metals and then dabbling around the edges with option contracts on the miners. My favorite gold fund is VGPMX, but it may be closed right now. It has done great the past three years I have owned it (41% annualized return over 3 years). I started buying another fund, GGN, early this year when VGPMX was closed. GGN is a “natural resource” fund and so has a lot of energy stocks as well as gold and basic materials. It also has a very good yield at 6%. There are other good precious metals funds that can be found on Morningstar or other websites.

Once I have my core position, I trade around the edges when the stocks are moving up. Precious metals and basic material stocks are very volatile, so they create good trading and option opportunities. I have been playing with AU, GG and AUY. The latter is a small cap and so very volatile. It is also a darling of the day trading crowd, so really moves fast. I just closed out my positions on AU that I have held off and on for four years. I will get back into AU when it approaches $40 again. I will probably sell put options to get in. Same is true for GG which I closed out in June when it was around $27. Now it is over $30, so probably got out too early. I just got back into AUY this week as it is well below its 52 week high. I sold (20) October 12.50 put contracts for 0.65 each on Friday (worth $1300 on Oct. 19 if AUY finishes above $12.50). That price is still good and will be on Monday (with the price of AUY at $13). I am looking for $15 or $16 in the next 6 weeks if gold stays at these levels.

Selling put options, you may end up with the stock if the price drops. That has happened to me with all the gold stocks along the way. If it happens, I just hold the stock knowing that the price is volatile and I will have a chance to get out at a profit. This is what I just did with the AU (Anglogold) and GG and AUY in the past.

Other conservative gold plays include the bullion ETF (GLD). You could also look at the silver ETF (SLV). Large cap miner possibilities are Newmont (NEM) and Barrick (ABX).

I think gold might double in 2-3 years from this level. It depends on the Fed and tax / spending policy. As long as we run fiscal deficits and also cut interest rates / create excess money, we will continue to see a devaluing dollar which encourages the price of gold to rise. If Congress and the Fed decide to protect the dollar, by raising interest rates and taxes and/or cutting Federal spending, then gold will decline in value. But I am not betting on that in the short term (during an election year).