By Darrell Delamaide, MSN MoneyThe current pullback in commodity prices is a great opportunity to get on board now and then enjoy the ride when economic growth kicks in again and drives prices higher.
That is, if you believe the experts.
A different play on commodities
Prices for many commodities remain high by historical standards. Oil prices have quadrupled over the past decade, gold has more than tripled, and many other commodities have doubled. Yet the pros don't see a bubble, and they reject comparisons with the bubble in high-tech stocks that burst at the beginning of this decade.
"Many of the tech companies had no assets, no business and no earnings, and people were buying their stock anyway," says Dale Doelling, the president of Trends in Commodities, an advisory service. "In commodities, you have a simple supply-and-demand situation. Demand far outstrips supply."
That view is shared by Emanuel Balarie, the author of "Commodities for Every Portfolio: How You Can Profit From the Long-Term Commodity Boom" and editor of CommodityNewsCenter.com.
"It's Econ 101," Balarie says. "We are in the midst of the commodities bull market of a generation."
Balarie repeats the familiar argument that China, India and other rapidly industrializing countries will need more and more oil, copper and other raw materials, and that their needs won't go away even though demand will fluctuate with the economy.
Doelling sees most commodities breaking through to new highs after the current drop in prices has settled. The price of natural gas is now only 25% of its real value, Doelling says, while silver is much undervalued compared with gold. The price of silver, now trading for about $9 an ounce, is around an 80-1 ratio versus gold and should return to its historical ratio of 35-to-1 soon, Doelling says. He sees a breakthrough ahead for silver, with it rising to $30 to $40 in the coming months and possibly topping $50 next year.
"I'm telling everyone I know to buy silver," he says.
One-stop shop for commodities
If there is a bright future in commodities, how does the individual investor exploit it? How do you buy silver? Well, as with most other commodities, you can buy silver in a number of ways, and the proper choice will depend on how much money you have to invest and how you feel about risk.
Silver coins are one way. Anyone can buy and hold silver coins without a lot of fuss. The same is true for gold. The ready availability of gold and silver coins has made these two precious metals among the most popular commodities with retail investors. Check the Internet for dealers of coins; there are plenty. Take some common sense precautions in selecting an online dealer. Is the Web site comprehensive? Does it show a fixed address? And is it easy to contact the dealer on the phone? Look for a dealer who has been in business for five or 10 years and who has an affiliation with a Better Business Bureau or a professional association.
If coins are your choice, store them in a safe place. Remember, they are money. You don't want $10,000 worth of silver coins in your bedroom closet any more than you want $10,000 in $20 bills under your mattress. Drop by the local bank, get a safe-deposit box and stash the coins there. If you insist on keeping them at home, have the right insurance.
Another simple way to have a direct stake in the physical metal, without having to worry about storage and insurance, is to buy into an exchange-traded fund, such as the iShares Silver Trust (SLV, news, msgs) or PowerShares DB Silver Fund (DBS, news, msgs). There are ETFs in numerous single commodities, from gold and silver to timber and coal.
If you want a stake in commodities but don't want to put all your eggs in one basket, consider an ETF that tracks broad-based commodity indexes, such as the iShares GSCI Commodity-Indexed Trust ($GSG.EU, news, msgs), which mimics the Goldman Sachs Commodity Index, or the PowerShares DB Commodity Index Tracking Fund (DBC, news, msgs), which follows the Deutsche Bank Commodity Index.
ETFs are like mutual funds in that they pool money from a range of investors, but they trade like stocks on a stock exchange. They have surged in popularity in recent years because they offer investors a chance to create their own diversified portfolios while minimizing management fees. Some traditional mutual funds, such as Rydex Commodities Strategy (RYMEX), also track broad-based commodity indexes.
More-venturesome investors can trade directly in futures and options on commodities. Options give investors the right to buy or sell a given amount of commodities at fixed prices. They allow investors to generate a lot of leverage, and the risk is confined to whatever investors pay for the options.
Just remember that options trading is high-risk. Your losses may be limited to the amount you paid for the option, but your chances of getting wiped out are a lot higher than they would be with, say, a solid stock.
Futures contracts ratchet up the risk even further. They give the investor maximum leverage but also maximum risk. An investor can pay an initial total of about $4,000 for a futures contract for 100 ounces of gold, worth about $74,000 at recent prices. Basically, the contract entitles you to purchase the gold at that price at a date in the future. If the price goes up, you are in the money for the full amount of the gain.
The problem is that the contract holder is on the hook for the full loss if the price goes down. As the price of the commodity drops, holders of contracts will get margin calls, requiring that they put in more funds with every price decline.
How to buy gold
Commodity pros caution that beginners should not buy futures contracts unless they have a healthy cushion of cash to meet margin calls in the event of a price plunge. If that sounds like you, you can open an account with a reputable broker on one of the commodity exchanges and confer with the broker about the best way to achieve your goals.
If a full contract for 100 ounces of gold or 5,000 ounces of silver seems too daunting, there are smaller contracts for half the amount and half the initial investment.
For people who feel like they need more assistance in navigating futures investing, Balarie recommends an investment in a commodity trading adviser. CTAs are a little like mutual funds, but they invest in commodities.
In fact, Balarie says, you might want to consider putting money into several different CTAs or into a CTA-oriented fund of funds to get a diversity of investing strategies. Some managers will be trend followers and will profit most when prices are rising, while others will focus on arbitrage or will short a commodity and profit most in a volatile market with sharp price swings. Before you send a check to a CTA, review the company's background through the National Futures Association.
Managed futures funds traditionally have been for high-net-worth individuals, but there are some funds that require a minimum investment of only $10,000 and funds of funds that have even lower requirements.
Balarie believes every portfolio should have some commodity component. Even if you are skeptical about the future of commodity prices and don't want to speculate on their continued strength, commodities offer a way to reduce the overall risk of your portfolio through diversification and a useful hedge against inflation, he says.
"People think they are diversified if they have a hundred different stocks," he notes.
Commodities, which historically don't correlate with the rise and fall of equities, offer real diversification.
Doelling sees another advantage to commodity investments: their high liquidity. Unlike real estate or even some securities, most commodity futures can be liquidated overnight. Doelling focuses on oil and gas, gold and silver, and wheat, corn and soybean contracts.
"If I get really worried about what's going to happen in financial markets, I can liquidate everything and convert it into something I trust," Doelling says -- like physical gold.
Even in less-catastrophic scenarios, many investors might feel better having the insurance that a commodity investment provides.
Published Oct. 29, 2008
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