Is the era of paper assets, such as shares and bonds, over for now? Are we moving back to a period when it will be things you can touch and feel, such as commodities, that deliver the best returns?This seems to me to be a good question to ask in a week when all the stock and bond market’s attention has been on the Bank of England’s latest decision on interest rates.
From an investment point of view, the most important decisions to get right are always the ones that reflect long-term underlying shifts in the relative pricing of assets. In 1980, with hindsight, the big insight you needed to make yourself wealthy was to realise we were entering a great disinflationary cycle.
The past 20 years have seen interest rates fall from 15 per cent to 20 per cent to less than one third that level. The taming of inflation has produced exceptional returns for holders of bonds and equities, as well as property, another so-called real asset. Commodities, by contrast, have experienced the other side of the coin.
With odd exceptions, until the past couple of years we have been witnessing a long and sustained bear market in physical assets. The trend of the world’s global commodity index has been to fall steadily but remorselessly for most of the time since 1980. The 1970s were exceptionally good ones, not just for countries or companies that had energy resources, but for those who owned commodities in general, including gold and other metals.
The point that comes out from this kind of analysis is that these powerful secular trends are the ones investors want to have running in their favour. Yet at the time new and important investment trends begin, most of us are looking the other way. In part, this simply reflects the dynamic of the capitalist system: investment bankers, brokers, traders and the media all naturally tend to spend their time on the sectors where the money is and the action is (or has been) hot.
You can list countless examples of this. In the 1980s, when Japan was reaching the zenith of its bull market, hardly a year passed without news of some new financial services firm opening an office in Tokyo. Today all the attention is on hedge funds and other alternative assets, which are clearly going to cost a lot of people quite a lot of money, if not in absolute terms, at least in terms of opportunity cost.
As the entertaining investment commentator Marc Faber says, it is not just that the big investment trends are largely invisible at the outset. It is that the focus on today’s winners largely obscures the opportunities such imbalances inevitably create elsewhere. In 1980, 28 per cent of the S&P 500 was made up of energy or energy-related stocks; yet you could have bought shares in Wal-Mart, a company nobody knew or cared much about, for a tiny fraction of their present worth.
In 1990, Japan accounted for more than 40 per cent of the market capitalisation of the global stock market index. Yet as the market started to falter, the obsession with equities and equity derivatives persisted, diverting attention from what Mr Faber calls “the greatest bond market rally in history”. In that time, yields on long-dated Japanese government bonds fell from more than 6 per cent to 1 per cent in a decade, creating huge capital gains for those who dared touch them.
Mr Faber’s detailed knowledge of market history leads him to suggest the aftermath of speculative bubbles invariably leads to market leadership switching elsewhere: it rarely reverts back to the asset class that has suffered the boom and bust. It seems safe then to assume that the US stock market, and western equities in general, will not experience another sustained bull market for some time. Strong rallies like the one we have seen this year are another matter; they are to be expected, but are probably mostly trading opportunities rather than long-term sources of superior returns.
Which brings us back to commodities. Although they commanded acres of newsprint and brokerage coverage 20 years ago, now you have to look much harder to keep track. Jim Rogers, the globe-trotting investor I mentioned a couple of weeks ago, told me he knew the bear market in commodities was coming to an end when the top Wall Street brokers suspended their in-depth commodities coverage two to three years ago.
Mr Faber also thinks commodities are the place to keep an eye on. Prices of many commodities have risen substantially in the past couple of years, but if we are seeing the start of a longer-term trend, the lesson of history is that there could be plenty more to come. It is symptomatic of the present situation that there are only a handful of funds left offering exposure to pure investment in commodities.
But there are other ways to buy into this trend if you think the broad case for diverting some of your assets into these classes is correct. One is to buy commodity futures: gold, silver, coffee, sugar, rubber, wheat, corn or cotton. A second way is to buy into those economies or companies that will benefit from any secular revival in commodity prices.
Mr Faber suggests that the best route is to give yourself exposure to emerging economies rich in natural resources. This is also in part because he believes that Asian stock markets, and emerging markets in general, are also likely to do better as a class than western stock markets. They are certainly more attractive on valuation grounds, and I would add Australia to the list.
The bottom line is that, until the recent rally, the price of commodities had fallen to its lowest level relative to shares or other financial assets in living memory. You cannot be certain how long-lived this revival will be, but the argument that commodities in general will outperform financial assets over the coming years looks well-founded, and will be more important to your long-term wealth than any consequence of this week’s interest rate rise.
davisbiz@aol.com
