Commodity Prices Peaking?

Regarding the commodity price discussion by Stephen Leeb in a recent newsletter, I think we can have it both ways, both the Barrons and WSJ positions. We are in the midst of a "short term" correction in commodity prices. Basically, the price increases got ahead of themselves at a time of weakening demand. The commodities markets are heavily influenced by speculative cash flows in today's market. It has become a favorite play ground of hedge funds and hot money. The size of the commodities markets is relatively small compared to the amount of funds available to chase those commodities, so the prices are easily moved around by speculative money flows. I agree with the 30% correction forecast by Barrons, and we are just about half way there on gold with the price in the upper 800s.

But I also agree with the WSJ article which makes the case for supply constraints as the "long term" problem for commodities pricing. New supplies of natural resources and ag products are hard to bring on line. Demand will not create instant new supply like it might for financial products or electronics, which are very easy to ramp up in terms of production (all financial products require is a paper and pen). New mines or oil wells require land acquisition, permitting, support infrastructure (roads, power, etc), labor in places where it may not be already available (Northern Canada), large capital funding, plant design and engineering, etc. And as the most accessible resources are tapped out, the remaining resources are in harder and harder to develop locations (mining seems to go with mountainous terrain for example).

So, I think we can consider both arguments and invest accordingly. If you like to trade short term, like me, the trade now is to be short the commodities. But if you are more of a buy and hold investor, then the proper trade is long. And the new lower prices make this a decent entry point for gold, copper, iron, etc. Ag commodities will also be a good buy if they pull back a bit more.

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).