Warren Buffett told annual Berkshire Hathaway shareholders Saturday that commodities are in a speculative phase. Jim Rogers disagrees.
May 8, 2006
 Today,
iTulip.com’s President Eric Janszen interviewed investor
James Rogers to hear what Rogers thinks of Warren Buffett’s
comments to annual Berkshire Hathaway shareholders Saturday on
commodities and to get an update on the progress of what he views as
the early stages of a long term bull market in commodities.
Warren Buffett mentioned at the shareholders meeting Saturday that, "We
had a lot of silver at one time, but we don't have it now."
He noted, "something like copper is speculative on both sides of the
market--you are looking at market that's responding more to speculative
than fundamental forces." Buffett believes the price rise in
at least these two commodities are the result of speculation not
fundamental supply and demand, and he implies that commodities are in a
speculative phase generally.Rogers has been frequently featured in Time, The Washington Post, The New York Times, Barron’s, Forbes, Fortune, The Wall Street Journal, The Financial Times, and most publications dealing with the economy or finance. He has also appeared as a regular commentator and columnist in various media and has been a visiting professor at Columbia University. Brief biography: Jim Rogers started his career as an investor with Arnhold and S. Bleichroeder in the early 1970s. Rogers co-founded the Quantum Fund, a global-investment partnership. During the next 10 years, the portfolio gained more than 4000%, while the S&P rose less than 50%. Rogers then decided to retire – at age 37. However, he didn’t stay idle. While he continued to manage his own portfolio, Rogers served as a professor of finance at the Columbia University Graduate School of Business. In 1989 and 1990, moderated WCBS’s “The Dreyfus Roundtable” and FNN’s “The Profit Motive with Jim Rogers.” At the same time, he was laying the groundwork for an around-the-world motorcycle trip. In 1990-1992, Rogers fulfilled his lifelong dream: with a companion motorcycling 65,065 miles across six continents, a feat that landed them in the Guinness Book of World Records. As a private investor, he constantly analyzed the countries through which he traveled for investment ideas. He chronicled his one-of-a-kind journey in Investment Biker: On the Road with Jim Rogers. His latest book, published in 2004, is Hot Commodities, How Anyone Can Invest Profitably in the World’s Best Market. Janszen: Long time iTulip.com readers dodged the Internet Bubble and Real Estate bubble bullets and purchased some gold back in 2001 when we pointed out that it was trading at 13% of its inflation-adjusted peak price. Since then we’ve seen significant gains in precious metals. Warren Buffett mentioned at the annual Berkshire Hathaway shareholders meeting Saturday that, "We had a lot of silver at one time, but we don't have it now." He noted, "something like copper is speculative on both sides of the market--you are looking at market that's responding more to speculative than fundamental forces." Buffett believes the price rise in at least these two commodities are the result of speculation not fundamental supply and demand, but he implies that commodities are in a speculative phase generally. Do you agree? Rogers: Recently, copper prices may have been influenced by hedge funds and other investment pools as has silver. Both have gone up in price very quickly over a short period of time, and that does suggest speculative activity. But it’s important to keep in mind that silver, for example, in spite of these gains is still trading at 25% of its inflation-adjusted peak price. It may be accurate to say recent gains have been driven by speculation but I disagree that fundamentals will not drive prices of these commodities higher in the long term, over the next ten years or so. The supply and demand factors and historical peak prices tell me that they have to go much higher before they can be declared speculative markets. That will happen eventually, that that phase is a long way off. Janszen: Can hedge funds and other investment pools control these markets and make them risky to invest in? Rogers: They can try, but in the long run attempts to manipulate commodities prices always fail. Take oil, for example. Six trillion ($6,000,000,000,000) of oil trades every day. Not even governments can control those kinds of capital flows, not for long. That goes for currencies, too. Short term, yes they can be manipulated. But eventually market forces take over, and the supply-demand market forces for oil long term will drive prices up. Governments can try to support the dollar, for example, but in the long run these efforts will eventually fail. Janszen: Are there other commodities that have not been the focus of speculation that are a better bet today than copper or precious metals because they are cheaper and haven’t gotten the attention of hedge funds? Rogers: Sure. Sugar is trading 80% below its high, and corn and wheat 60% below their peak prices. And that’s without adjusting for inflation. Do that, and they’re trading at around 5% of their peak prices. That’s cheap! They have a lot of upside. Janszen: How about oil? Many say that oil is now in a bubble phase because it’s increased from $10 per barrel in 1999 to $70 a barrel today. Rogers: If the fundamentals for increased prices remain, prices will continue to rise. Show me where major new sources of oil supply are going to come from and I’ll buy the idea that oil is going to decline in price long term. Janszen: That covers the supply side of the oil equation. What about demand? The US economy looks to be headed toward a crisis as housing prices decline, something we have been warning our readers about since 2002, and the dollar declines as foreign creditors pull in their horns and stop lending us the money we need to buy their exports. We’ll see inflation, rising interest rates and likely recession, not just for the US but for the world. Won’t a slowdown in the world economy lower demand for oil and cause the price to decline? Rogers: That’s not how it works. During a time when many of the world’s largest economies were in recession in the 1970s, oil prices increased several fold. The UK went bankrupt during that period and had to be baled out by the IMF. But oil and commodity prices boomed. Another major boom in commodities started during the depths of the Great Depression, in 1933, during what was arguably the worst collapse in global demand in history. Global trade fell more than 50%. Janszen: I bought your book Hot Commodities at the book store versus online because I wanted to see what book stores are putting on their shelves in the personal investing section. That’s a good indicator of what the bookstore thinks consumers want. The shelves are full of books about mutual funds, stock index funds and getting out of debt. There seem to be fewer get rich quick in real estate books, but the only book I could find on commodities investing was yours. Why so little interest in commodities if we’re in a bull market? Rogers:We’re in the early stages of a commodities bull market. Until 2001, commodities had been declining in price for decades while stocks went up. Over that period of time, an entire industry has developed to create, market and sell stock related products. Not surprisingly, the bookstores are appealing to the same consumers targeted by the companies that sell stocks related products, such as mutual funds to index funds, for decades. The market for these products has developed to the point where there are now 70,000 stock mutual funds and ten – count them, ten! -- commodities funds. That means an entire industry, from the traders to the book authors, has to develop to create, market and sell commodity products. Janszen: Most people I talk to either don’t understand or simply don’t like commodities. They think pork bellies and cows, silos of grain. Commodities are unfamiliar. Then there are the people who simply don’t like what commodities represent – destruction of the environment, not to mention what appears to be unproductive economic activity. When they think of stocks, they think of innovation, technology, wealth creation through human activity. Cool new cell phones, Internet based media, exciting new technologies that improve productivity and expand the economy. These are positive and exciting things. They also like houses. They are status symbols. The kids run around in them. Your home is your castle and all that. Houses are nice. Commodities are dirt and arsenic and trucks ripping up the earth and cutting down trees, smoke stacks spewing pollutants, stinky pig farms. Do commodities have an image problem? Rogers: This is all understandable and part of what has made commodities such a great investment opportunity: irrational investor behavior. Fact is, without commodities the world cannot function, and markets don’t care if you like an asset or not. These things go through cycles. The average investor is more interested in how cool a company or technology is than in the fundamentals of the business. Mostly they’re following price, which eventually leads to hysteria at the top of bubbles as your site pointed out during the Internet bubble and housing bubble. Some day the shelves will be full of books on commodities. Janszen: Then it will be time to start thinking about shifting out of commodities and into stocks? Rogers: Absolutely. Janszen: Have the emergence of Exchange Traded Funds (EFTs) and Commodities Index Funds like your Rogers International Commodity Index (RICI) make commodities investing more accessible to investors who are used to buying stock mutual funds or index funds from their brokerage account? Rogers: It’s true that a portion of the rise in some commodities such as gold and silver is related to the fact that to invest in these you don’t have to go buy bullion anymore but can buy shares in an EFT from any brokerage account. This makes the process more familiar and the concept of buying shares in an index is more intuitive for the average person who is used to buying shares of stock in a company or a mutual fund. But buying commodities directly is also trivial and I explain how to do it in my book. Janszen: Why not buy stocks in companies that produce commodities, such as mining stocks, or a mutual fund that’s composed of stocks in mining companies? Rogers: There is a lot of research that shows that over time stocks in companies that produce commodities always under-perform the commodities themselves. This is mostly due to the way these companies are managed. Most are not managed well, and no one has been able to consistently guess which ones will be well managed and which ones poorly, so it’s very hard to make money in commodities based on equities. Janszen: During this commodities boom, stocks can be expected to decline, correct? Rogers: Yes. They tend to be inversely correlated. The fundamentals that drive up commodities prices are not good for stocks. Rising commodities prices increase the input costs for companies in many industries, from housing to consumer goods. More expensive oil, for example, eventually shows up in the cost of making goods that contain a lot of plastic, so profits get squeezed as manufacturers are reluctant to pass these additional costs onto consumers, who will buy less product if prices are raised to quickly. Janszen: You mention in your book that oil, gold and other commodity prices collapsed between 1980 and 1982. You attribute this to the fact the rising oil and gold prices in the early 1970s motivated exploration and that by 1978 world oil supply was greater than demand for the first time in many years. This started to impact oil prices in 1980. But didn’t Fed Chairman Paul Volcker’s policies to kill inflation with Fed funds rate hikes up to 19% in 1982, and the on and off three year recession that produced in the US cause this collapse in commodity prices? Inflation declined from an average of 18% in 1980 to -.04% in 1983. Surely that had a big impact on demand and thus prices?  Rogers:Volcker certainly deserves a lot of credit but the market was well on its way to solving the oil price problem on its own. The government was having to print a lot of money to pay for the war in Vietnam as well as to pay for oil that was in short supply relative to demand, and this during recessions, mind you. So for oil, the inflation was caused by a supply-demand imbalance. For gold, the price that peaked at $870 in 1980 (around $2000 in current dollars) was driven by investors’ expectations of future inflation. In investors’ experience, inflation is all mixed together, the kind created by a shortage of oil relative to supply and the kind created by the government to finance a war. Even after the printing to pay for the war and other government spending was reduced, inflationary expectations were built into contracts and people’s expectations generally. This is the inflation that Volcker attacked and did so successfully. Janszen: So gold went down because of Volcker and high interest rates and oil went down because of increased supply and also high interest rates. In other words, it's best to think of commodites themslves as money, whether it's oil or gold or wheat. Rogers: Well put. Janszen: Where does that leave us with gold and other precious metals today? You mention in your book that 75% of all money going into exploration is going into gold mining. That certainly doesn’t bode well for the supply side of the gold price equation. How about the demand side? Rogers: Don’t get me wrong. I own both gold and silver. But it’s not an investment in commodities like wheat, sugar or corn. Gold and silver are insurance against the kind of inflation that Volcker was fighting in the early 1980s and currency related risk. If things go haywire for the dollar and currencies generally, demand for gold and silver will go through the roof. So everyone should have some, as insurance. But keep in mind if the world really gets into trouble, the demand for wheat and corn will be even higher, so their price is likely to increase even more. Gold and silver investors need to expand their horizons with respect to covering these kinds of risks. Janszen: You mention in your book that several set backs are likely during this long term bull market in commodities and mention China as a prime candidate, due to classic hyper-growth capital over investment and poor banking system controls; China’s likely to blow up at some point, sooner or later. What about the US economy and the dollar? The US is not exactly the poster child for balanced trade and sound fiscal policy. Rogers: The US economy is on the road to disaster and the dollar along with it. Another reason to invest in commodities is to hedge the risk of a major decline in the dollar, such as by investing in raw materials produced by countries like Canada. There you get the double benefit of both the appreciation in prices of commodities Canada produces and an appreciation in the Canadian dollar relative the US dollar. Janszen: I really enjoyed speaking with you again. Rogers: My pleasure. Anytime. Discuss this interview... |
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