3 July 2002 - Breakfast of Champions?

Looking for a hot tip? Here’s my advice: Do not buy the hype from Wall St and the press that stocks always go up. There are long periods when stocks do nothing and other investments are better.

That’s not what a lot of people expect me to say these days. (It’s probably not what they want to hear, either.) The Dow Jones Industrial Average and Standard & Poor’s 500 indexes, after all, are down substantially, trading at levels not seen since 1998. To many investors, it seems like a perfect time to do some bargain shopping for battered quality stocks. Everyone knows “sell high and buy low” (though I’m always surprised at how few people follow that adage), so now appears to be an ideal time for a bottom feeder like me.

Sorry, bottoms in the investment world don’t end with four-year lows; they end with 10- or 15-year lows. More important, many investors seem to have forgotten a hard reality: There are frequent periods when stock markets don’t do much.

From 1900 to around 1920, for example, U.S. stocks floundered while the economy grew. Then stocks skyrocketed in the 1920s. In 1966, the Dow was trading around 1,000. By 1982, it was at 800, down 20 percent over 16 years and that is not adjusted for the high inflation of those years. So much for long-term investing.

Over the next 15 years the market soared.

We recently had a decade of unprecedented growth. Is it such a stretch to think that we might now see a mediocre period of equal length as has happened throughout history?

Despite my distaste for U.S. stocks, though, don’t think I’m sour on all investments. I do believe there are some good bets out there. It will come as no surprise to faithful readers that I believe this is a great time to invest in stocks from other countries, where stock markets haven’t been as exploited as the U.S. market has been in the last decade. On my recent trip around the world, I bought shares of companies in places like China and Chile, countries I feel have great potential. In fact, right now I own shares of companies in 28 countries. Of course, it is best to go to many of these nations to open brokerage accounts in order to buy stock, but I’m all in favor of Americans expanding their horizons. Plus, there are mutual funds that cater to the international investor as well as many foreign stocks that trade as American depositary receipts on U.S. exchanges.

The coming decline in the US dollar will make foreign stocks and currencies even more attractive.

I think this is also a great time to invest in private equity, helping companies grow from the ground up. It’s much more effective to build a company quietly and soundly during a down market than it is to, say, try and ride a boom-and-bust cycle during a high-flying market, something like what we saw during the go-go 1990s. The stock market, many discovered, isn’t exactly the best place to raise money when you’re building because — surprise! — it turns out you need real earnings and real growth opportunities to build a healthy company. The “promise” of earnings just doesn’t cut it.

It is easier to build a real company in times like these than when even your hopeless competitors can raise easy money from a delusional stock market. Fortunately real companies will have less competition now.

Perhaps the best investment opportunity I see these days is in commodities. Commodities are real assets — raw materials and natural resources from all over the world. They’re not “sexy” investments at the moment. It’s hard to get investors fired up about pork bellies or orange juice; few people get calls from their broker about a great new lead mine. That may soon change.

Commodities have a lot going for them, particularly in our current economic environment. They are a great investment during an inflationary period (such as now – despite what the government and Wall Street try to tell us) because increases in the price of raw materials reflect the rising costs of goods. In addition, commodities tend to zig when the equity markets zag. During that flat period for the U.S. stock market between 1966 and 1982, the commodity markets were booming.

Historically, there has been a bull market in commodities every 20 or 30 years, and I think we’re already in the throes of a new one. And while raw materials can lose value, the price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt. You’re buying a contract to purchase a real, tangible bushel of corn or several hundred pounds of coffee.

On the flip side, commodities can go quite high, as high as anyone is willing to pay. Gold, you might remember, went from $35 an ounce to $850 during the 1970s alone.

The main reason few people have talked about commodities lately is because that market has been in a massive slump for about 25 years. Keep in mind that commodities’ prices move not because of magic, but because of shifts in supply and demand. During the late 1970s and early 1980s, high prices led companies to overproduce, leading to substantial excess supply and stockpiling. As a result, inventories swelled, demand dried up, and prices started to fall. A fiscal crisis in Asia and Russia in the late 1990s only exacerbated the problem.

Sugar peaked at $65.65 in 1974 and then fell to $2.56 in 1985. Oil went from $2 in the early 1970s to as high as $40 a barrel in 1981 before falling to $10 in 1986. Many commodities producers went bankrupt or closed facilities. No one expanded operations. I can probably count on one hand the offshore drilling rigs built in the last 20 years or the new rubber plantations. The tough times, though, helped many commodities producers become lean and mean through consolidation, mergers and cost-cutting. All that excess supply has been sopped up. Demand has continued growing, particularly in fast-expanding economies like those in Asia.

That said, most people don’t think it’s possible to make money in commodities. Many brokerages reduced or closed their coverage during the 1990s in favor of the red-hot equities market. You can no longer buy commodities at Merrill Lynch – one of the largest brokers in the world. My guess is many analysts and even executives are too young to know how profitable a hot commodities market can be. They will soon.

The commodities market is showing signs of life. Cocoa prices have doubled over the past year, rising 20 percent since the beginning of 2002 alone. Gold has recovered from a 20-year downturn; the price of an ounce is now around $315. As of June 24, the Dow Jones AIG Commodity Futures Index, a marginal benchmark for the commodities world, is up 11 percent since the beginning of the year.

I started the Rogers Raw Materials Fund (RRMF), an index fund that tracks price moves of 35 raw materials on commodities exchanges, on Aug. 3, 1998, just before I left on my trip. Since then, it’s up about 50 percent while the S&P 500 is down.

Is it too late, then, to get involved in commodities? Definitely not.

Investors rarely recognize beginnings and ends of bull markets. We can look at recent painful history, but the same pattern has repeated for centuries.

US Shares
1998     1999
Advances         3928     4224

Declines           5879     5467

[Source: Wall St Journal]

Sixty percent [60%] of shares were down in the US in 1998 and the same pattern repeated in 1999 – hardly a bull market. Yet the press and Wall Street were braying to buy stocks because of the New Economy and the bull market. The public finally poured huge amounts of money into the stock markets in the 1999-2000 periodeven though the bear market was already underway.

Throughout history the public has always piled into the latest bull market right at the top so few have caught on to the bull market in commodities. I’ll sell when Merrill Lynch has commodity brokers in every office again and the TV networks are broadcasting from the soybean pits in Chicago.

An investor who put his money in the S&P Index in 1982 did extremely well, but so did one who got on board in 1983-85. I suggest you consider putting your money in a raw materials index now and staying with it for the next several years.

So what specific commodities do I like now if you do not want a fund? As a rule, I like to look for the ones that are beaten up. Hogs, orange juice, sugar, and coffee, for instance, have been especially hard hit. It sounds like a breakfast menu as investment plan, but it could be the best money you ever spend, particularly if U.S. stocks continue to flounder. After all, breakfast is the most important meal of the day.