Monday, August 24, 2015
On February 9, 1966, the Dow Jones Industrial Average reached 995. It was the latest high in a long uptrend in stocks that had lasted 24 years.
The investment public had made so much money in stocks for so long that confidence in the market was extremely high.
When the public gets that confident in any investment, it's poised to disappoint sooner or later. This time was no different. The Dow dropped and rallied a handful of times over the next 16 years... But it didn't eclipse its February 1966 high by more than 6% until November 1982.
The 1970s were a horrible period for stocks. But during this same period, a small group of investors made a fortune... outside of stocks.
They made a fortune in commodities.
If you want to make commodities a part of your plan to prosper during a bear market in stocks, you need to understand a few key aspects of the market. Today, we'll tell you what you need to know to be successful...
Commodities are the "building blocks" of civilization. We burn some of them for fuel (like oil, natural gas, and coal). We grow some for food (like corn, rice, sugar, and wheat). We mine some for industry (like copper, zinc, and nickel).
Commodities can go through spectacular booms that can come when stocks are rising, falling, or moving sideways.
For example, as stocks stagnated in the 1970s, gold and silver experienced run-ups of 1,129% and 2,428%, respectively. The price of oil shot 1,034% higher. In the last nine months of 1973 alone, wheat prices soared 145%.
In other words, commodities can "zig" when stocks "zag."
Shifting money into commodities was a great way to survive and thrive during the 1970s bear market in stocks. Legendary traders like Michael Marcus and Bruce Kovner (interviewed in our favorite trading book, Market Wizards) used commodities during this time of lackluster action in stocks to massively increase their wealth.
We could see something similar happen in the next bear market. Lots of commodities have been crushed over the past few years, while stocks have hit new all-time highs.
Plus, the governments of the world are devaluing their currencies in attempts to stoke their struggling economies. After the latest actions in China to devalue its yuan, the "currency wars" are now back in the news. The currency wars could eventually trigger inflation like we had in the 1970s... which could push commodity prices higher.
Before you start buying, though, it's important to keep in mind that the general trend of commodity prices has been down for hundreds of years. Mankind constantly develops new technologies that improve how we extract and use natural resources. This puts constant downward pressure on prices.
Also, owning a commodity is much different from owning a high-quality business. A commodity like corn or silver doesn't produce cash flow like a high-quality business or a rental property. It won't pay dividends. A commodity just "sits there."
For these reasons, it's not useful to view commodities as long-term investments. It's much more useful to view them as trading vehicles. Or, as we often say, it's best to "rent... not buy."
The supply/demand of a commodity like silver or corn can cause commodities to double or triple in value in a short time. But after making these gains, the trader should start looking around and noting where the exits are. A commodity that doubles or triples in price in a short time can fall 50% in the same amount of time.
We can't state this emphatically enough: Commodities can be a useful part of your "bear market survival plan." But view them as trading vehicles, not long-term investments. This brings us to the next key idea...
Since commodities are priced in U.S. dollars, a big move in the greenback can affect all commodities. A move higher for the dollar means your dollar can buy commodities for less. In other words, commodity prices go down.
This price action leads to most people thinking about commodities as a group. They'll often say things like, "Commodities went down today," or "Commodities are a great buy right here."
But when it comes to placing actual commodity trades, those generalizations aren't useful. Individual commodities move according to their own supply/demand dynamics. Cotton is a different market from gold. Copper is a different market from corn. Sugar is a different market from cattle. They should be viewed and traded accordingly...
When it comes to putting money to work, the broad generalization of, "It's time to buy commodities," is no more useful than saying, "The weather in America is going to be nice today."
Sounds good, but we need more information.
Now that we've covered all of this, how can we trade commodities?
Well, there's the futures market. This is where commodity producers, commodity consumers, and speculators get together and trade massive amounts of commodities. But it's not a good place for the beginner. The futures market can involve huge amounts of leverage, which can quickly decimate your account.
We also have exchange-traded funds (ETFs), which you can buy and sell like stocks. Some ETFs track commodity prices, commodity indexes, and groups of commodity producers. These can be a great trading tool if you're looking for an easy way to diversify without paying lots of trading fees.
We've used lots of commodities ETFs in the past in DailyWealth Trader... And we'll likely use them again soon.
Finally, lots of individual companies benefit when commodities boom. Commodity producers, royalty companies, and services firms are a few examples. These are generally riskier than a diversified ETF... But they can make for great speculations.
As we saw during the 1970s, commodity trading opportunities can be huge. They can skyrocket when the stock market is tanking. That's why monitoring the commodities market for trades is part of our bear market strategy.
Brian Hunt and Ben Morris
For a better understanding of the drivers behind the big booms and busts in commodities, you have to learn about "cyclicality." It's an incredibly important concept. You can read all about it in this interview with natural resource expert Rick Rule.
On Friday, Brian Weepie showed Growth Stock Wire readers that we're getting close to a bottom in coal. "The best time to invest in natural resources is when everyone hates them," he says. "And coal is probably the most hated fuel in the U.S. today." Learn which four energy stocks he recommends adding to your "watch list" right here.
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