Spooked by inflation and searching for the next new thing, investors are putting a fresh spin on ancient trading strategies and investments.
Derivatives–from gold and oil futures to exchange-traded funds–were arguably the hottest investment ticket in 2004, but they have their roots in ancient Asian rice trading and in American futures markets dating to the 19th Century.
Last year, futures trading in raw materials such as gold and crude oil shattered records in New York. Fueled in part by new products that appealed to smaller investors, the Chicago Mercantile Exchange saw its publicly traded shares soar more than 200 percent to become one of the 50 largest stock gainers for the year.
Exchange-traded funds–baskets of securities derived from stock, bond or commodity indexes, aimed at individual investors and traded like a single stock–soared in popularity from an upstart category more than a decade ago to a serious rival of old-line mutual funds. Barclays Global Investors’ iShares exchange-traded funds captured the third-largest truckload of new investor cash, right on the heels of fund behemoths American Century and Vanguard, according to the Financial Research Corp. in Boston.
New products were introduced allowing retail investors to speculate in gold, real estate and raw materials, as well as stocks and bonds–and more are coming.
One of the best-selling business books so far this year has been a new offering from “Investment Biker” author Jim Rogers. Its title: “Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market.”
As of the first few weeks in 2005, the 10 biggest gainers among mutual funds tracked by Morningstar were a bear-market strategies fund and nine precious metals funds.
More recently, as of Feb. 4, mutual funds specializing in natural resources and utilities outperformed all other categories of domestic stock funds, according to Morningstar.
The big question for 2005 and beyond: Are commodities and other derivatives just a flash in the pan, or do they deserve an ongoing place in your portfolio? And if they do belong in your future, how can you make them work for you?
Rogers swears the bull market in commodities still has at least a decade to run. Historically, he said, they last about 18 years, and this one started in 1999. Cycles run long, he said, because of the time it takes for industries to identify shortages in natural resources, ramp up production and then, typically, overshoot to produce a glut of supply.
“The shortest bull market I could find [in studying history] was 15 years, and the longest was 23 years,” he said. “Somewhere between 2014 and 2022, this bull market will come to an end.”
For a contrarian tip for investors who feel gold and oil have been overdone already, Rogers suggests looking in your sugar bowl.
Sugar prices, he says, are 80 percent below their all-time high, brought down by overproduction and worries about continued demand. “If I’m right, even if sugar quadrupled, it would still be below its all-time high,” he said. Of course, Rogers concedes, there is the brother-in-law problem.
“We all have a brother-in-law who lost his shirt in soybeans,” Rogers quips, nodding to the incredible–sometimes incredibly destructive–power of margin trading in the futures markets, which allows investors to trade huge contracts by putting up relatively small amounts of cash. “The thing is, you don’t have to use the leverage.”
That leverage is alluring, however, and getting easier all the time for novice investors to access, thanks to a regulatory easing five years ago.
Customers who trade with E-trade and CyberTrader (Charles Schwab’s arm for active retail traders), among a limited handful of others, can now buy futures contracts directly from the futures pits via electronic screens that show all available prices.
Futures exchanges, in turn, have trotted out smaller-lot futures contracts, enabling smaller investors to hedge a portfolio or speculate in future prices of certain indexes, all for a fraction of the upfront money an exchange-traded fund would require–and at lower trading costs.
Derivatives’ critics say the recent price run-up and euphoria around commodities conjures up images of the Internet stock craze in the late 1990s and emerging markets debt popularity before that.
“For long-term investors, there is almost no reason to be in commodities,” said Benjamin Tobias, a certified financial planner in Plantation, Fla., who believes the derivatives markets are still unfriendly places for small investors.
“You have to be very selective. The easy money in commodities has been made,” said Paul Taylor, chief investment officer for BMO Harris in Montreal.
Alternative investments
All that said, a murky outlook for U.S. stocks this year, predictions of continued drops in the dollar and inflation fears all point to more interest in alternative investments, experts said.
Add in high expectations for increasing demand for raw materials from the rapidly growing market of China, and you can pretty much bank on more commodities-oriented investment products in the pipeline in the coming years, said Lee Kranefuss, president of Barclays’ exchange-traded fund business.
“ETFs are just a fraction of the fund world, but they offer a compelling proposition,” he said, noting their low expense ratios and broad market exposure.
More products coming
Industry sources expect more retail-oriented trading products based on gold and other precious metals, expanded bond indexes and even government economic data are heading investors’ way in 2005 and beyond.
Another way to play the raw materials strategy is to focus international investments on key global growth areas. One example is Canada, rich in natural resources with a currency rising against the U.S. dollar. The Fidelity Canada fund was up 52 percent in 2003 and 24 percent last year.
“Investors are always attracted to new, hot ideas,” cautions Greg Forsythe, a Charles Schwab & Co. senior vice president who specializes in portfolio modeling. “But over time, a diversified stock and bond portfolio does well. This stuff [commodities] should be no more than 20 percent of your portfolio, and it should be thought of as being sprinkled in to lower volatility more so than adding return.”
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The basics on some basic stuff
What are commodities? Commodities include all sorts of bulk goods–such as grain, metals, livestock, oil, cotton, coffee, sugar and cocoa. Within specific grades, the product is generic in quality. Commodities can be sold on the spot market for immediate delivery or traded on exchanges in the form of futures contracts.
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New ways to invest in timeless products
Investors look to centuries-old derivatives markets for an inflation hedge and growth but are finding them in new packages that offer individuals easier and more direct access.
Product: Real estate
Twist: Real estate investment trusts allow individuals to bet on rising prices without owning and managing real property.
2004 Results: 32 percent gain (category)
Product: Commodities
Twist: No trading jacket required. Two broad commodity-based mutual funds let investors buy into actual raw materials.
2004 Results: Pimco Commodity Real Return Strategy (PCRAX): 15.7 percent
Oppenheimer Real Asset (QRAAX): 19.6 percent
Product: Gold
Twist: Hold the Krugerrands. State Street Global Advisers’ exchange-traded gold fund directly tracks the price of gold.
Results: Launched late in 2004, the fund has attracted nearly $2 billion in assets.
Product: Financial futures
Twist: Exchanges’ “miniature” contracts now aimed directly at active retail traders, with lower trading costs ($8 per round-trip trade) versus $15 for most discount stockbrokers trading exchange-traded funds.
Results: Record volume and huge gains in 2004 for public shares of Chicago Mercantile Exchange.
Product: Exchange-traded funds
Twist: Launched in the early 1990s, the funds have exploded in recent years, both in volume and product offerings.
Results: Assets grew by 47 percent, to $222 billion, in 2004.
Product: Currencies
Twist: No need to globe-trot. Investors can hedge their dollars with bank accounts in foreign currency-denominated accounts, buy shares of unhedged bond funds, or place bets on single regions or countries.
Results: iShares FTSE/Xinhua China, advised by Barclays Global Investors, was the first index to offer exposure to the 25 largest mainland China stocks. Has collected more than $120 million since November inception.
Source: Morningstar Inc.
