Wednesday, January 30, 2008

HOT COMMODITIES by Rogers (Review)

Book: Hot Commodities
Author: Jim Rogers
Subject: Investing

In Hot Commodities, Jim Rogers gives us an introduction to the world of commodities investing. Of the different asset classes available to investors, the commodities class receives little attention from average investors or the institutions that sell investment services. However, Rogers references studies that show that commodities give comparable returns to stocks. Moreover, he explains how stocks and commodities traditionally run in inverse cycles: when stocks are in a bull market, commodities are often in a bear market and vice-versa. Since long term bull and bear markets can run in cycles of 13 to 18 years, sticking to either to the exclusion of the other means your investments can needlessly languish due to ignorance of how to diversify into commodities.

The book is divided into four parts. First, Rogers familiarizes the reader with the history, terminology, and mechanics of how the commodities markets work. In the next section, he analyzes the demand side of the commodities market in the growing economies of Asia, especially China. The third part of his book analyzes specific commodities including oil, gold, lead, sugar and coffee. And the final section of his book is a collection of reference charts and graphs of different indexes and histories.

The strong lesson I took from the book is that you cannot be a dilettante commodities investor. Whereas you might buy a stock being totally ignorant of how to value it and watch it rise in market price because a lot of other ignorant investors are bidding it up, in commodities you are working against professionals in a very simple market. There are not lots of nuanced measures to interpret like price-to-earnings or book-to-sales in stocks. In commodities, there’s just one: supply versus demand. If the demand for a commodity outstrips supply, the price will go up. If the supply exceeds demand, it will fall. You make money either way by making accurate readings of the available and new supplies versus the current and future demand. The other powerful factor in commodities trading is that you are buying on margin. In other words, you only have to pay for a small percentage of the commodity lot you buy. This presents opportunities for huge gains or losses in a very short time.

Buying on margin is the source of the horror stories of the amateur commodities investor. For example, the rules of the exchange might allow you to buy LONG $100 worth of a commodity A for $5 (different commodities have different percentages). Buying long means you are speculating that the price will go up. If the price does go up to $105, you can sell your contract and you’ve made a 100% gain! However, if the price falls to $95, your entire investment could be wiped out as all accounts are cash accounts that have to be settled at the end of the trading day. To make money investing in commodities, Rogers recommends study and specialization. In other words, he advises speculators to become experts in a single market like copper or sugar and to put in the study to learn just how much of the stuff is out there and how it gets used.

Current returns place us today in the midst of a commodities bull market. Rogers happened to have predicted its advent fairly accurately and places its beginning in 1999. The historical trend is that the long term commodities bull will last around 18 years placing us somewhere in the middle of the current run. As evidence of these facts, many commodities like gold, oil, corn, sugar, plutonium and copper have doubled in price or increased in value by many multiples of their 1999 value. By comparison, the S&P 500 has languished in the same territory over that period and the NASDAQ has never recovered its peak value. A sensible definition of true investing (as explained by Professor of Finance Michael Rozeff) – as opposed to speculation – requires diversifying your wealth across as broad a range of the asset classes as possible to get the average value of the markets. To that end, I can recommend Roger’s book as an excellent introduction to an education in commodities.


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