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Date: Saturday January 15, 2005 10:32:00 am | Views: 118
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    Owning Oil, Gold, and Land Creates Real Riches

    Jan. 05 — Some of the sharpest minds on Wall Street are betting that you’ll make more money in metals than Microsoft the next few years. The new bull market is in stuff, not stocks, they say.

    We’re talking about land and oil and gold, the commodities that once made John Jacob Astor, John D. Rockefeller and the Hunt brothers very rich men.

    Stocks have languished the past five years, but commodities – real assets that you can touch, see or taste – have soared. The Commodities Research Bureau index, which measures a basket of commodity prices, has gained 36% since the end of 1999. The Standard & Poor’s 500-stock index, which measures the performance of a basket of high-quality stocks, is down 20%.

    A soaring commodities cycle can go on for “years, if not decades,” says John Brynjolfsson, manager of Pimco Commodity Real Return Strategy fund, one of the few mutual funds that invests in commodities futures.

    That means we could be in the early stages of a seismic shift in the financial markets: a bull market in commodities that could last another 10 years. A rip-snorting market in sugar, steers and steel would send shivers through Wall Street. “When you have a bull market in commodities, you don’t have one in stocks,” says Jim Rogers, co-founder of the Quantum fund, a high-octane hedge fund.

    That has sent investors flocking to commodities. Volume on the commodities exchanges is soaring. Trading in agricultural futures at the Chicago Mercantile Exchange rose 15% last year. Overall commodities trading rose 31%, vs. 12% for the New York Stock Exchange.

    For the most part, investing in commodities is a route the well-off take to greater wealth. Already, the latest commodities run-up is creating a new generation of land and oil barons among the USA’s richest people. But even little-guy mutual fund investors are being lured by the call of gold, coal and real estate.

    Learning from the past

    The last big boom in commodities began in the 1960s, as late as 1982, when the cycle was almost finished. Many of the nation’s self-made millionaires – people such as Marvin Davis and T. Boone Pickens – had made their money in assets such as land or oil. One of the most popular TV shows of the era, Dallas, was centered around an oil baron, the nefarious J.R. Ewing.

    But by 1999, most of the wealthiest had made their money through initial public offerings of telecommunications, software and computer companies.

    Now, five years later, talk about a change in fortune: Most of the 45 new members of the 2004 Forbes 400 list of the nation’s wealthiest people made their fortunes not through stocks but stuff such as natural resources, hotels, shoes and sandwiches.

    Dan Duncan, for example, made his $4.2 billion in natural gas. Leonard Blavatnik got his $2.4 billion in oil, coal and real estate. Evgeny “Eugene” Markovich Shvidler rode oil to his $1.8 billion.

    Only four of the 2004 newbies made their fortunes in technology.

    Suddenly, investing in commodities no longer seems quite as unsavory to investors, and they are drawing a lot of people with a lot of money.

    The number of commodity pools – mutual fundlike vehicles for investing in futures – has soared to 3,500 from 1,714 five years ago.

    “Five years ago, if I showed our products to 100 clients, we’d have 20, 30 new investors,” says Craig Caudle, whose Liberty Funds Group in Lubbock, Texas, puts together commodities pools. “Today, it would be closer to half, maybe even higher.”

    Commodities pools, as are hedge funds, are designed for high-net-worth investors – people with net worths of $1 million or more. Typically, those people rely on financial advisers to steer them toward commodities, Caudle says. That’s where most of his new clients are coming from.

    Institutional money managers, who invest for pensions, trust funds and other big pots of money, are dipping their toes into the commodity pool, as well.

    The Harvard Endowment is devoting 13% of its assets to commodities, for example, and the Ontario Teachers Pension fund has put about 6% of its assets in commodities. And $25 billion in institutional money is now benchmarked to the Goldman Sachs Commodity Index, up from $8 billion in 2000.

    Even small investors are showing interest in commodities. “Everyone has a brother-in-law who bought soybeans and lost his shirt,” says Rogers, author of Hot Commodities, an investment book. But a few mutual funds, such as Pimco Commodity Real Return and Oppenheimer Real Asset, have brought limited commodity trading to small investors.

    StreetTracks Gold Trust, an exchange-traded fund that invests only in gold bullion, has seen its market value soar to $1.3 billion since its debut in November.

    It’s no wonder commodities have been pulling in investor money. Prices for commodities have been going through the roof. Oil prices soared as high as $55 a barrel in 2004, up from $32.52 at the start of the year. But oil isn’t the only hot commodity these days. Copper has gained 30% ; hogs are up 45%.

    There are two reasons for the climb in commodities prices:

    –Demand is outpacing supply. Consider lead. Its price soared to $976 a ton last year, its highest ever. That’s despite the fact that two major uses for lead, as an additive to gasoline and to paint, have disappeared. What’s pushing up prices? Lack of supply. Lead production in the USA fell to 237,000 tons the first six months of 2004, from 266,000 tons the first six months of 2003.

    “In the 1980s and 1990s, you had people calling you about hot stocks, but not one person called you with a hot lead mine,” says Rogers. “But lead mines deplete, and there has only been one new lead mine opened in 25 years. No one has invested in production capacity.”

    Overall, the USA had 82 active metals mines as of June, down from 92 in 2002, according to the U.S. Geological Survey. Gold production fell to 226 tons in 2003, vs. 331 tons in 1993. Copper production dipped to 1.1 million tons in 2003, from 1.8 million tons 10 years earlier.

    And you can’t just open a new mine. You first have to find the metal you’re looking for. You have to figure out if the location makes economic sense. Then you line up investors and get government approval before you turn the first dirt. On average, it takes five to seven years from discovery to production.

    In the meantime, consumption is growing. The war in Iraq is one factor. “War has never been good for anything but commodities,” Rogers says, because the demand for iron, steel, lead and copper soars.

    But the biggest driver is China. The Chinese economy grew at a 9.1% rate the 12 months ended in September, the latest data. Its imports rose 39% to $51.1 billion, according to Economy.com. Its total trade – exports and imports – cracked $1 trillion for the first time in November.

    –A new inflationary cycle is starting. By definition, inflation drives down the value of paper money but increases the value of real assets.

    To create a new inflationary cycle, you have to begin with a surplus of dollars and a shortage of goods. That makes money cheap and commodities expensive. Commodity bulls say that’s happening. The Federal Reserve, desperate to head off recession from 2001 through 2002, flooded the economy with money, primarily by making loans dirt cheap.

    In addition, we have a massive federal deficit. That, combined with easy money, has weakened the value of the dollar but driven up commodity prices. For example, it now takes $1.33 to buy a euro, up from 86 cents in 2002. But gold, the premier real asset, has soared above $425 an ounce from a low of $255 in 2001.

    Inflation hawks argue that neither the Federal Reserve nor the bond market will allow inflation to rekindle. But it’s tough to snuff out once it gets started, because large segments of the population would love a whiff of it.

    Farmers, for instance, are helped because inflation increases the value of their commodities, crops and land. The same goes for mining and mineral companies. Rising inflation is linked to rising employment and higher wages.

    Politicians find it hard to muster support for inflation-fighting measures. “It’s hard to get the inflation-fighting backbone needed to fight inflation,” Brynjolfsson says.

    All this signals not-so-good news for stocks. The bottom line is that rising commodities prices mean higher expenses for most companies. Higher expenses mean lower earnings, and lower earnings mean lower stock prices.

    Consider a company such as Kellogg’s, the cereal maker. In a period of rising commodity prices, the company would pay more each year for corn, packaging and transportation.

    “When the price of raw materials is declining or under control, companies do well,” Rogers says. “When commodities are going through the roof, they don’t do as well.”

    Marc Faber, publisher of the aptly named GloomBoomDoom.com Internet site, says the world is now at the inverse of where it was in 1981, at the peak of the last commodities boom. Back then, energy stocks made up 28% of the S&P 500, while financial stocks were 7%. Today, energy accounts for 8% of the S&P, while financials are more than 30%. To his mind, it’s time for the cycle to tip back toward real assets.

    Rogers figures the bull market in commodities started in 1999 but could still have a long way to run.

    “Six years after the bull market started in 1982, most people were not aware of it,” he says. “It usually dawns on people slowly that a bull market in commodities has started.”

    We might be past the dawn of a great commodities bull market. But it could yet be early morning.

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