Friday, February 5, 2010

Commodities: Too Popular? Sometimes One Can Take Contrarian Thinking too Far

Mish raises a familiar objection to commodities and by extension, contrarian investments, and raises a question of high importance at EBR is his post, Commodities Kiss of Death? Is the Reflation Trade Over?

He points to the interest of the California State Teachers' Retirement System in putting a very small part of its funds into commodities and points to that as contrarian evidence that a further fall is underway:

Pension plans are looking to hop on the commodity bandwagon now after copper prices have quadrupled in the past eight years, and crude oil has more than doubled. . .

China is on the verge of imploding (or blowing up attempting to prevent a implosion) yet pension plans and other misguided souls are plowing into China and commodities. These are contrarian indicators.

Another take is that IF there were a cost-effective way to own commodities (not so easy to achieve), the cost of creating refined metals and raw foods (etc.) is actually a reasonable way to tie into the real world. In contrast, the true bubble is in the stock market. The idea that ownership of the industrial company Deere & Co. is in any way a good way to obtain a correlation to the inflation/deflation possibilities of raw materials pricing is just plain silly.

In the same column, Mish admits to being a bull, after all, on commodities:

Yet, I am a also believer in peak oil and commodities for the long haul. However, for the short-to-intermediate term I am sticking with my target for the price of crude to fall back to $55.

Since pension funds are only for the long haul, it makes little sense to, on the one hand, criticize their interest in diversifying their exposure to add commodities and on the other hand express bullishness about the investment class on the time frame which pension funds are required to consider.

Over the past century and perhaps through the centuries, the regions of the world that have had advancing prosperity have done so by using physical raw materials to create wealth by adding human ingenuity. Thus, commodities' returns have not kept pace with theoretical stock market returns in the U. S. or most of Western Europe. Whether that relationship continues is, of course, unknown. What is nearly certain, however, is that the concept of exposure to an underlying necessity of life is a reasonable thing for an investor to do, especially a conservative organization such as a pension fund. The real challenge is to find an appropriate investment vehicle, given the ETFs such as USO (oil) and DBA (ag) that have such high operating costs that they are guaranteed to underperform their benchmarks.

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