The Winners Will Be Those Who Look to Gold and Commodities

by: Bill Cara November 09, 2008    

Bill Cara

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[Excerpted from Bill Cara's Week in Review]

This was a strange week where U.S .equity markets fared badly, except for Friday’s closing half-hour. The German and UK markets, which closed up on Friday, missed the full extent of the late session rally in the U.S., and so closed down on the week.

The U.S. retail stores sales data was terrible. Traders are not thinking mañana; they sold Consumer Discretionary stocks (XLY) down -8.8%. Bankers too were being squeezed as T-Bill yields dropped almost to zero (annual yield of +0.22%). People fall into two camps: (i) no money, or (ii) unwilling to risk the money they do have.

There was an interesting discussion this weekend I took note of:

[Don Coxe interview in Nov 10 Barron’s] “Stocks are cheap but they can get cheaper; we know that. We got back to the Dow having a multiple of 5.9 in December of '74, which was the foundation of Warren Buffett's wealth because he started buying at that level. The Dow isn't anywhere near 5.9 (its multiple last week was 11), but some of my favorite stocks are trading at lower P/Es than that. I can tell you they are the fertilizer, oil and agricultural companies.”

“When I came back from a trip two years ago, I said the biggest commodity story is going to be food, bigger than the other ones. It is high-protein food. The way to play that is through the fertilizer stocks, the genetically modified seed stocks and the farm-equipment stocks.”

My response: Other analysts have also compared this market to 1974 P/Es. It is a different situation entirely. The stagflation in the 1970s was much higher, with bank rates often in the mid-teens, and it sucked the P/Es right out of the market. I have no clue why analysts don't look at the data… But, I do like Don's picks.

Apparently, Don (the BMO strategist) likes, in order: (1) agriculture, (2) gold, (3) energy.

I do agree with his picks. But I also believe the broad market P/Es are right where they should be in a long-term cycle bottom phase. Also, it’s the cash flow per share multiple that is more important today, as cash is king.

There are so many junior oil and gas companies that are selling at minuscule cash flow multiples, and have very low debt service costs. Obviously, if the companies are in North America, they have no trouble selling their products. As traders start to take on more risk, the junior energy stocks will soar.

And I agree that food is going to be in huge demand, which makes the need for fertilizer a given. In China for instance, I think the government has committed to a policy of moving hundreds of millions of people from their tiny farms to homes in the city, which will help (i) create a broader-based consumer economy, and (ii) organize the development of large farms like in the U.S., which are far more efficient. That policy will help the fertilizer companies and the manufacturers of farm machinery.

As for gold, I see that governments around the world have been working out economic rescue programs. The problem there is that money doesn’t come on trees. It’s expensive. You can print it from paper from trees, but the cost in devaluation of what it represents is very high. Nobody more than Americans are committed to these bailout programs. So, ultimately the winners will be those who avoid bonds and who buy physical commodities and gold.

So, I do think Don Coxe is making mostly accurate statements.

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This article has 40 comments:

  •  
    Nov 09 12:44 PM
    You can eat food and you can burn energy. What can you do with gold?
    Reply | Link to Comment
  •  
    Nov 09 01:05 PM
    By mutual hallucination, a store of value. If people believe gold is a store of wealth, as they have for millennia, then it functions that way. Unless people stop believing. Native Americans were never fixated on gold; most cultures have been. Gold fever.


    On Nov 09 12:44 PM Briggsy wrote:

    > You can eat food and you can burn energy. What can you do with gold?
    Reply | Link to Comment
  •  
    Nov 09 01:06 PM
    Jim Rogers agrees. Bonds are a short sell and Oil, Gold and Agriculture should be bought on weakness.

    jimrogers-investments....
    Reply | Link to Comment
  •  
    Nov 09 01:16 PM
    By its massive liquidity injections the Fed is reflating the economy. There wil be a price to pay down the road for this but it is down the road. Unless they want a repeat of the great depression of the 1930s there really is no other rational option. I agree that ag and fertilizer stocks will play. However if these do well then the broader equity indices will reflate as well.
    Reply | Link to Comment
  •  
    Nov 09 01:29 PM
    Yes,you can eat food, and burn oil/gas etc., but you can sell gold as ALL commodity prices rise, so you will have the money to buy the food and oil. Some central banks (like Spain) have stopped selling gold, which they have used as a backing for their paper currency however, they will sell again when the price gets higher, in order to help pay down their national debt.
    Spain has about 1 years coverage left in gold reserves, after that, who knows?
    Reply | Link to Comment
  •  
    Nov 09 01:53 PM
    I have been following this train of thought for a while now and believe it to be correct. I own physical Gold ETF's and have exposure to agriculture.

    As a question though, does anyone have an idea what time frame we may be looking at for inflation from the bailout's to filter into the economy? Any ideas would be good.
    Reply | Link to Comment
  •  
    Nov 09 02:22 PM

    I think the problem with the author's view is that inflation will NOT filter into the economy because we're suffering from deflation.

    In which case, owning things like gold is not a good idea.




    On Nov 09 01:53 PM Dan Lewis James wrote:

    > I have been following this train of thought for a while now and believe
    > it to be correct. I own physical Gold ETF's and have exposure to
    > agriculture.
    >
    > As a question though, does anyone have an idea what time frame we
    > may be looking at for inflation from the bailout's to filter into
    > the economy? Any ideas would be good.
    Reply | Link to Comment
  •  
    Nov 09 02:31 PM
    Briggsy: "You can eat food and you can burn energy. What can you do with gold?"

    What do you do with little bits of green paper?

    Dan Lewis James: "As a question though, does anyone have an idea what time frame we may be looking at for inflation from the bailout's to filter into the economy?"

    Take a look at previous crashes.
    Reply | Link to Comment
  •  
    Nov 09 03:03 PM
    I may be wrong but wasn't the hyperinflation of Nazi Germany ended overnight by issuing a new currency backed by gold? The price of gold sets the currency conversion rates.
    Reply | Link to Comment
  •  
    Nov 09 05:48 PM
    The bail out programs are not inflationary. They are deflationary. ZERO percent of the bail outs is coming from printed money. All of it is coming from new government debt. Money is simply being transferred from those who have the cash now to those in need of cash. Usually banks would do that job but they happen to be the ones that need the cash now, so the government must do it.

    A commodity's ONLY value derives from its usefulness in production -- not from its scarcity. If the global economy will be depressed for the next few years, where will the demand for commodities arise? The price of a commodity will always revert to its value. That is exactly what is happening today. Arguments about population growth, topsoil density, peak oil, debt bubbles, currency implosions are irrelevant. If you buy commodities now, you will be left holding the bag for quite some time.
    Reply | Link to Comment
  •  
    Nov 09 06:29 PM
    "The bail out programs are not inflationary. They are deflationary." Huh? Most people agree that the deleveraging is deflationary, but the bailout? How can the creation of trillions of new dollars make the dollar stronger, even if they are backed by new debt? Won't people begin to lose confidence in our ability to service that debt?
    "The price of a commodity will always revert to its value." Doesn't everything? What will the value of a dollar be after 5 years? You can't expect demand for US debt to continue unabated, especially as we need to fund medicare, social security, and our bloated military.
    Commodities have real, tangible value and are limited in supply. The value of dollars are based on faith in the government and are in infinite supply.
    Reply | Link to Comment
  •  
    Nov 09 06:50 PM
    Silver & Gold will protect your wealth so that you can buy food and oil. It frees you from the dollar and the tax collector. But the really nice reason is that it is in the early stages of a big fat bull market, especially silver.
    Reply | Link to Comment
  •  
    Nov 09 07:27 PM
    The U.S. government will not have any trouble servicing its debt. If at some point in the future economic growth fails to produce revenue sufficient to service the debt, the federal government will simply have to cut services. This is exactly what is happening in California and New York right now. Debt in and of itself is not inflationary and does not determine currency value. Government cutting services is deflationary. Currency value is determined by relative cost of inputs to the manufacturing process. Higher labor costs, insurance costs, regulatory costs, environmental costs etc in the U.S. have driven the dollar down over the long term -- until now. The U.S. is in a deflationary period while developing economies like China and India are in an inflationary period. Labor and regulatory costs in China are rising rapidly. Export manufacturing is leaving China now for realms with cheaper input costs. As a matter of fact, there is evidence that a small amount of manufacturing is actually returning from China to the U.S. The last thing I'd buy right now is commodities.


    On Nov 09 06:29 PM huskerbob wrote:

    > "The bail out programs are not inflationary. They are deflationary."
    > Huh? Most people agree that the deleveraging is deflationary, but
    > the bailout? How can the creation of trillions of new dollars make
    > the dollar stronger, even if they are backed by new debt? Won't
    > people begin to lose confidence in our ability to service that debt?
    >
    > "The price of a commodity will always revert to its value." Doesn't
    > everything? What will the value of a dollar be after 5 years? You
    > can't expect demand for US debt to continue unabated, especially
    > as we need to fund medicare, social security, and our bloated military.
    >
    > Commodities have real, tangible value and are limited in supply.
    > The value of dollars are based on faith in the government and are
    > in infinite supply.
    Reply | Link to Comment
  •  
    Nov 09 07:41 PM
    we have leading indicators to judge inflation.
    seekingalpha.com/artic...

    commodities do not do well in recessions
    seekingalpha.com/artic...

    cash is king at this second. keep you eye on the economy. we have leading indicators that are not government issued
    seekingalpha.com/artic...

    do not fall in love with any investing style as this market is unstable. good recommendations are worthless the second they are printed. past performance and historical fundamentals have not shown accuracy over the last 18 months.
    Reply | Link to Comment
  •  
    Nov 09 08:01 PM
    "Currency value is determined by relative cost of inputs to the manufacturing process." "Debt in and of itself is not inflationary and does not determine currency value. Government cutting services is deflationary."
    Fantastic! Now that I know that debt and currency supply don't determine currency value, I am wondering: where is my million dollar stimulus check? Why not send a million dollars to everyone on earth? Then just cut the government budget to strengthen the dollar. That should get the economy going! Things are looking up!
    Also, if our government cuts service to US citizens in order to pay foreign debtholders, will anyone be upset?
    Reply | Link to Comment
  •  
    Nov 09 08:21 PM
    You can print paper money but nobody can print gold. Paper money is just bank's promise to pay. From time to time, banks are going down and paper money they issue are worthless.

    Gold never was and never will be worthless. It never failed to pay for the last 4,000 years.


    On Nov 09 12:44 PM Briggsy wrote:

    > You can eat food and you can burn energy. What can you do with gold?
    Reply | Link to Comment
  •  
    Nov 09 08:25 PM
    Very good comment from the hand. The market is too volatile now and too many things are moving, too many variables.

    Theories on how the economy works usually disregard many variables because they assume them to be stable. Because they usually are stable, the theories work most of the time.

    But these days everything is moving, so no past theory is gonna work, other than the theory that "there will be another bull market in the next 20 years." Sure. But I am not sure that's very useful. Even if you were to figure out all the variables, the big unknown is the government now, and what sort of measures/regulation, incentives, tax cuts/increases it will bring over the next year or two, and how that will change the game, and what sort of secondary effects it will have.

    Best to stay out of this mess for a while. I was in Vegas a few weeks ago, and actually have a much better ROI in Vegas then in the stock market -- and I got out of the market in February!
    Reply | Link to Comment
  •  
    Nov 09 09:00 PM
    Jim Rogers lastest blurb about GOLD I read, was that gold may be affected by government selling gold to raise money ---I've got AUY in my portfolio so I'm interested in that new angle. This is a departure from Rogers previous thoughts on GOLD. Rogers was at a conference in New York City last week.
    Reply | Link to Comment
  •  
    Nov 09 09:16 PM
    Like all other metals, gold is a commodity. Only my fellow Indians worship it. Even today, I'll take Berkshire over gold.

    Gold is DEAD - www.bapcha.com/?s=gold
    Bapcha
    Reply | Link to Comment
  •  
    Nov 09 09:24 PM
    How low will gold go before it goes up?
    Reply | Link to Comment
  •  
    Nov 09 10:17 PM
    all these posts have left me rather confused.

    though i do wish to add that gold is not a "regular" commodity and it has until recently been the standard world currency. so in this irrational time you have a flight to safety as you have already seen in other areas and in gld. it will continue to outperform in the long term as long as volatility is present. people always return to where they know its safe.


    come on its been proven time and time again in every aspect of our own lives!
    Reply | Link to Comment
  •  
    Nov 09 10:51 PM
    Your tone makes your post difficult to respond to. There is not enough savings to generate a million dollar stimulus check. As I said, the government can only borrow from people who have cash to lend. And I did not say things looked sanguine. Cutting government services is distinctively possible over the next year and I doubt anyone is going to like it including people who have been demanding it. We are in a serious deflationary spiral that has already wrecked commodity prices and threatens to shackle them down for the next several years. Answer this: how is the government bail out going to be inflationary when the banks won't loan the bailout money? Has it occurred to you that in a deflationary economy there are few profitable business projects that require loans. Businesses now are borrowing just to stay afloat. If you're a bank, do you continue loaning to a customer who is just trying to stay afloat? No. This is not looking good for the economy or commodities.


    On Nov 09 08:01 PM huskerbob wrote:

    > "Currency value is determined by relative cost of inputs to the manufacturing
    > process." "Debt in and of itself is not inflationary and does
    > not determine currency value. Government cutting services is deflationary."
    >
    > Fantastic! Now that I know that debt and currency supply don't determine
    > currency value, I am wondering: where is my million dollar stimulus
    > check? Why not send a million dollars to everyone on earth? Then
    > just cut the government budget to strengthen the dollar. That should
    > get the economy going! Things are looking up!
    > Also, if our government cuts service to US citizens in order to pay
    > foreign debtholders, will anyone be upset?
    Reply | Link to Comment
  •  
    Nov 09 10:53 PM
    the rule of thumb most often heard is that 10% of your portfolio is to be in precious metals...while they likely wont garner huge returns, they will stay tough with you through inflation, and should be bought during deflationairy periods as this is generally when prices are the cheapest. Positions, long AUY and hold the physical in silver.
    Reply | Link to Comment
  •  
    Nov 09 10:56 PM
    > The bail out programs are not inflationary. They are deflationary.
    > ZERO percent of the bail outs is coming from printed money. All of
    > it is coming from new government debt. Money is simply being transferred
    > from those who have the cash now to those in need of cash. Usually
    > banks would do that job but they happen to be the ones that need
    > the cash now, so the government must do it.

    I'm afraid you don't understand the nature of fractional reserve. The government can borrow $1 trillion, feed it to the banks via the fed, and effectively grow money supply by $9 trillion. M1 /= money supply. The only question is whether this reflationary effort will be successful, and when.

    >government cutting services is deflationary

    I thought you just said that government spending isn't inflationary. Huh?

    > A commodity's ONLY value derives from its usefulness in production
    > -- not from its scarcity. If the global economy will be depressed
    > for the next few years, where will the demand for commodities arise?
    > The price of a commodity will always revert to its value. That is
    > exactly what is happening today. Arguments about population growth,
    > topsoil density, peak oil, debt bubbles, currency implosions are
    > irrelevant. If you buy commodities now, you will be left holding
    > the bag for quite some time.

    Overly simplistic. Commodities are not always capital goods; when currency risk grows, commodities become investment vehicles. All commodities do, however, require production, and this often involves credit and/or minimal prices levels. It is entirely possible that we see, through a combination of bankruptcy and capital spending cuts, a significant decline in commodity production. Here the question is, which side of supply/demand will fall further?

    >Currency value is determined by relative cost of inputs to the manufacturing process.

    No. **Costs do not determine price**. Supply and demand determine price. With currency, labor costs are only one variable on the demand side. Unless you understand that there are two sides to every transaction - and that current events will effect both sides - then your prognostications are useless.
    Reply | Link to Comment
  •  
    Nov 09 11:31 PM
    the largest US pork exporter says business is awful as China is going back to a bowl of rice ... no animal protein... Don Coxe is yesterdays news... best to find analysts that play simple demographics... Boomers are aging and disposable income is going down 1% a year... so you can print all the money you want, you can guarantee all the loans to losers like GM and Ford, the only people who will do well is people who learn to live frugally and invest with the same vision!
    Meantime I got gold bars all over the place
    Reply | Link to Comment
  •  
    Nov 10 01:07 AM
    "There are so many junior oil and gas companies that are selling at minuscule cash flow multiples, and have very low debt service costs. Obviously, if the companies are in North America, they have no trouble selling their products."

    Uh...with a Dem Senate, Dem House, and a Dem Prez, can you say "Windfall profits tax"?
    Reply | Link to Comment
  •  
    Nov 10 03:10 AM
    "organize the development of large farms like in the U.S., which are far more efficient"

    Depends on your perspective. Ask all the American farmers who's lives were ruined when they were driven off their land in the push to "more efficient" (read easier to manipulate) corporate farming.

    Extremist-Capitalist tinkle down economics has brought the world to the verge of collapse. Some say that continued faith in bankrupt ideas is the way forward. Other say tangible assets like gold and silver are the answer.

    Very very soon we will see who is right and who is wrong.

    Reply | Link to Comment
  •  
    Nov 10 04:27 AM
    J Rancher - You are right: I apologize for the tone of my response.
    Two things:
    1. The government can't keep borrowing at this pace without raising interest rates. Total Fed lending now over $2 trillion. Bailout plans approaching $2.5 trillion, and certain to increase as Congress feels the need to "do something". The tax base is being destroyed by the minute, destroying the ability to service debt.
    2. What is a bank that doesn't lend money? It's not going to sit in a virtual vault gathering dust. Now that the government has shown that some banks will not be allowed to fail, will they become responsible stewards of taxpayer largesse?
    Reply | Link to Comment
  •  
    Nov 10 07:37 AM
    "The bail out programs are not inflationary. They are deflationary. ZERO percent of the bail outs is coming from printed money." - Jolly_Rancher


    Ummm ... check the data. The gub'mint is printing like never before:

    research.stlouisfed.or...

    As the chart depicted at the above FED link shows, the aggregate monetary base has nearly grown as much in the last two months as it did for the prior 20 years. That's a whole lotta printing.
    Reply | Link to Comment
  •  
    Nov 10 09:05 AM
    Borrowing can be very inflationary if the lender is a bank. It is called fractional reserve lending. Fractional reserve bankers are therefore thieves.
    Reply | Link to Comment
  •  
    Nov 10 02:18 PM
    "long on oil" is right on--Nazi Germany and fascism is the parllel. This is a very dangerous time we live in--and there's absolutely a "gold standard" that the market seems desparately trying to produce--around 800 an ounce or so--YOU GO GIRL! Can you even get the stuff? There has been a huge run on gold coins of late and there is definitely a shortage of government issued supply. When the banks start selling gold coins then I will consider them something other than totally worthless. Needless to say there are shortages of energy and food as well. As a guy told my buddy Vic at the bar the other night: "I've got 100 acres of prime farmland." My buddy Vic told him "I've got a gun." Oh, yeah--and the Democrats are finally going to "get things done in Washington." (so much for stamping out corruption.) The last time that happened there were over 30 million dead in Europe. What do all those buyers of firearms in America know that the rest of "the people of the world" do not? As the Rolling Stones said, "it's just a shot away."
    Reply | Link to Comment