Close-up: Commodities

Physician's Money Digest, December 2005, Volume 12, Issue 16

n.

Commodities: Bulk products such as metals, grains, and foods that aretraded on a commodities exchange.

As most physician-investors are aware, the marketruns in cycles. State Street Global Advisors pointsout that 25 years ago, during a strong inflationaryperiod, commodities like precious metals and oil were thedarlings of Wall Street. But as inflation subsided, stocksand bonds ruled the market and commodities took a hiatusfor back-to-back decades. Today, however, commoditiesare reappearing on investors'radar screens.

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Commodities: How Anyone Can Invest Profitably in the

World's Best Market

Commodities certainly have the ability to offer attractivereturns, compelling diversification benefits, andappealing exposure to powerful economic and demographictrends. But the challenge facing commodities,according to investment guru Jim Rogers, author of (Random House; 2004), is thatinvestors don't know much about them. In fact, saysRogers, many investment firms don't even have registeredbrokers for commodities anymore.

The Skinny on Commodities

IU E-Letter

In an interview with InvestmentU.com's ,Rogers explains that commodities are a lot simpler and easierto analyze than stocks. He cites natural gas as an example.

"It's pretty dumb stuff,"Rogers says. "If there's toomuch gas, it's going to go down. If there's too little, it'sgoing to go up. Natural gas doesn't know or care whoAlan Greenspan is. It just cares about supply and demand.And once you've made that analysis, it's a lot easier to buyand sell natural gas than to start analyzing 300 naturalgas companies around the world."

Why did commodities investing experience such asharp decline over the past 2 decades? Rogers points outthat people have been going into other businessesbecause there's been no money in commodities. Wheninvestors can't make money in an area, they leave it anddo something else. In fact, he says that no lead smelteryhas been built in America since 1969, and there have beenno new oil refineries built since 1976.

Rogers also points out that historically, when stockshave done well, commodities have done poorly and viceversa. As such, he believes the time is right for investors todip their toes into commodities investing once again.

Commodity Index Funds

According to FinancialSense.com, commodity indexfunds are a small but growing number of excellent high-quality,managed index funds. Because commodity pricescan fluctuate to wide extremes in both the short and longterms, commodity index funds attempt to minimize theseprice fluctuations and provide overall risk management.

The Web site points out that the selection and weightingof the specific set of commodities in a commodityindex fund are typically reviewed annually, or when thereis a major change in usage of any given commodity. Thisstrategic selection and weighting management providessome overall risk reduction in commodity index funds.

Other aspects of commodity index funds are that theirreturns are negatively correlated with stocks and bonds,but positively correlated with inflation. In addition, returnsare more positively correlated with changes in the rate ofinflation, but commodity prices are not highly correlatedwith each other.

Given the current state and conditions of the worldwideeconomy and markets, where stocks and bondsappear to be overvalued in many cases, there would be astrong case for commodity index funds as an attractiveasset class today. As Rogers points out, "Enron was a naturalgas company, and Enron went to zero. Natural gascan never go to zero. It can go down, obviously, but it cannever go to zero."

Commodity Indexes

If you're considering investing in a commodityindex fund, there are a good number to choosefrom. As with any investment decision, physician-investorsare encouraged to perform individualresearch on what would be the best and mostsuitable commodity index fund for them.

FinancialSense.com points out that most commodityindex funds will track a specific commodityindex. To assist in your research, examples ofsome of these commodity indexes include:

  • Goldman Sachs Commodity Index (GSCI)
  • Bridge/Commodity Research Bureau (CRB)
  • Dow Jones-AIG Commodity Index
  • Mount Lucas Management Index (DJ-AIGCI)
  • London Metal Exchange (LME)
  • Rogers International Commodities Index (RICI)

POP QUIZ

1) Commodities are defined as

  1. metals
  2. grains
  3. foods
  4. all of the above

2) Commodities tend to follow the law of

  1. buy low, sell high
  2. supply and demand
  3. give and take
  4. push me, pull you

3) When stocks and bonds do poorly, commodities tend to

  1. do well
  2. also do poorly
  3. do about the same
  4. bottom out

4) The last oil refinery built in the United States was in

  1. 1976
  2. 1969
  3. 1980
  4. 1985

5) Commodity index funds tend to track a

  1. mutual fund index
  2. bond index
  3. specific commodity index
  4. all of the above

Answers: 1) d; 2) b; 3) a; 4) a; 5) c.