On Friday we re-examined the Enterprise Inns secured bond. Though these bonds have come down a little, I still like them. Bonds are mostly ignored by private investors, but they represent 25% of my portfolio.
Commodities, too, go largely unnoticed by private investors, yet they make up a further 25% of my assets. Commodities have come off the boil recently: the CRB index (19 of the most traded commodities) is down about 20% since last summer.
Today I want to show you why I’m sticking with commodities despite their recent poor form. And I’ll also point you in the direction of a very exciting oil story that is brewing at the moment.
Why commodities have fallen hard
Take a look at this chart...
It shows the Thomson Jeffries CRB index over the last year. And it’s suffered quite a fall.
Talk of a hard landing in the Chinese economy and the easing of a bit of speculative fizz have undoubtedly softened the market for natural resources.
But to my mind there are three very good reasons why commodities should form part of a balanced portfolio with a long-term (20 years plus) outlook.
Stock markets may reverse – that’s good for resources
The BRICs (Brazil, Russia, India & China) seem to get all the attention when it comes to the emerging markets. They are massive markets and their economies have been growing at a fantastic pace. And that’s put considerable pressure on natural resources – it’s been driving the market upwards for over a decade now.
As the pace of growth has slowed over the last year, it’s put a downward pressure on commodities.
But there’s an awful lot more going on in the emerging markets. The frontier markets are a subset of emerging markets; they’re the countries whose stock markets are generally too small to be investable for the big Western funds. But make no mistake, many of these countries are on the move.
You look at countries like Vietnam, Cambodia, Indonesia, Pakistan, Mexico (I could go on and on)... all told there’s probably some three billion people looking to increase their standard of living.
Consider the fact that Chinese oil use (per capita) is just 3% of that in the States. Clearly oil use doesn’t need to go up to anywhere near that of the West for these guys to cause massive demand side ructions in the markets. I’m not arguing these populations will attain anywhere near the standards of living we enjoy... they just need to come out of the stone-age for the resource markets to come under pressure.
As the poor get ever so slightly richer, nearly all of their newfound wealth goes into ‘stuff’. While we in the West spend ever more of our wealth on services, these guys hoover up natural resources for the simple things in life... even if it’s just a sheet-metal roof.
That’s why I’ve been looking hard at oil plays of late – more on that shortly.
Ultimately, I can’t see any reason why what’s been playing out over the last decade won’t continue. Sure, there may be a slowdown from fantastic growth rates, but the emerging markets will continue to grow – and so the battle for resources is set to continue. Many frontier markets are throwing off the shackles of communism (or other dodgy regimes) and are embracing free markets. They have leaped into this millennium unburdened by debt – they are stuffed full of young people eager to create a better life for themselves. They will be competing against YOU for the resources over the coming decades.
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Supply constraints are baked into the cake
The '60s and '70s were golden years for the resource markets. Having suffered massive underinvestment during the depression years leading up to WWII, supply constraints spurred prices higher.
New investment headed into mining and oil exploration. And largely speaking, we’ve been living off that resource investment for the last 30 or 40 years. During the '80s and '90s precious little investment went into exploration. Why would it? What kind of fool explores for more copper when they’re losing money extracting the stuff from current operations?
Remember too that many of these resources are finite. That means it takes more energy and effort to produce each kilo of copper, or barrel of oil.
Sure, there’ll be technical innovations that help. Take shale gas for instance. But remember, all that’s happening here is we’re depleting finite resources at an ever-increasing pace... no great cause for celebration there!
The coming wave of commodity speculation
A few weeks back I pointed out how politicians set out to steal from natural resource companies. While we commonly associate political risk with countries in Africa or Latin America, it can just as easily happen to investors here in the West.
Australia recently upped the tax-take on its mining industry. While here in the UK, governments see no problem in windfall taxes on anything from North Sea oil to the water that comes out of your tap.
The point is that when the tax goes up, then not only does it leave less money to invest in production, it also removes the incentive to increase production. Over the next five or ten years, I can see many of the world’s exporters of oil turn into net importers. And it’s happening with other resources and commodities too.
But it’s not just on the business side of things that the politicos wade in and cause merry hell. It’s also in the more arcane side of things...
Yesterday we learned that Spanish banks are to receive over £80bn to keep them from insolvency. Now where is this cash coming from? Whatever way you look at it, it’s got to be an increase in money supply. You can call it a loan and use some jiggery-pokery to say why it’s not printing money. But frankly, it has to be.
And what do the banks do with the money? Well, they don’t loan it out to productive businesses looking to extract something useful out of the ground. No, they’d rather speculate on the resources themselves. That is, they like to gamble on resource prices going up, rather than invest in production that brings resource prices down.
You see, if they invest the money by offering loans to industry, then they tie up cash. They lose ‘liquidity’ – so instead, they pile into shares, commodities, dodgy government debt, or maybe just leave the cash on deposit.
I think we’ve got many years of money printing to come. And the benefits of the newly minted cash always go straight to the banking industry. NOT real industry.
To my mind that’s wrong. But it’s where we are.
To sum up then: Increasing demand, stagnating supply and speculative funny money all point to higher commodity prices over the medium to long term.
I’ll continue to keep commodities as a central part of my portfolio. And I’ll keep you abreast of how you can too.
Two very exciting frontier oil stocks
And finally – those oil stocks I was talking about…
Over the past few months, I’ve been scouting for some decent plays on our need for oil. I think there are some tremendously exciting opportunities in a couple of remote oil basins. I’ve looked at the Falklands. I’ve looked at some West African plays.
Then I read a fantastic new report on frontier oil by Tom Bulford. Tom points out two serious frontier oil prospects. One is in Namibia (apparently a geological twin of the great oil basins off the coast of Brazil). The second one, of all places, is in the Bahamas.
Have you had a chance to read Tom’s report yet? It’s high-risk stuff. But these are two very promising oil plays. And Tom has had some huge success in this field of late.
You can download the report here.
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