Your editor found himself discussing investments in a strange place last night: a CrossFit class.
John is a regular at the place. He’s a tall and lanky retiree.
I said: ‘You must be happy with the rally in bank stocks yesterday.’
‘Well, yes. But I’ve got a long way to go to get back to even. I bought AMP at $3.50. Even worse, I bought more at $2.50. It’s my punishment for being greedy.’
The adage about catching falling knives came out. Always a danger in the market.
And yet we just saw a possible signal for a major bottom in a key asset class.
Do we dare point it out?
We can’t help it. Read on to find out…
It’s this: Investment bank Goldman Sachs is planning to slash its commodity unit trading arm. There’s little profit in it anymore.
Your editor’s eyes latched on to this story.
Here’s why. Go back to around 1997.
The major Wall Street banks were doing the same thing: Dropping research and trading units around the commodity markets.
That’s because, for years, prices of ‘hard assets’ like gold had stayed at low levels and with little volume.
Commodities languished as an asset class.
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All the action was in internet stocks at the time.
Investor Jim Rogers points this out in his 2004book, Hot Commodities.
In 1998, Jim launched a commodities index…and bought up as many hard assets as he could.
Jim’s a contrarian investor. He gets excited when an asset hits historic lows…that means he’s getting it cheap!
Jim took comfort from the fact that the Wall Street banks were dropping commodities.
It hinted that sentiment was so low it could hardly get worse. That suggested his downside was minimal.
But the upside was huge if a catalyst came along…
And it did. You already know that part of the story. China’s industrialisation and urbanisation spurred a huge rise in demand for raw materials.
That’s not all…
Academic research in the early 2000s revealed that commodities could provide non-correlated returns and reduce risk for the average portfolio.
Wall Street began pushing commodities again on the back of this.
Investment poured into the market. By 2008, Jim’s commodity index was up over 400%.
The good times didn’t last…
A bottom forming here?
The global financial crisis came and smashed down demand.
A historic stimulus from China helped prop up the commodities market until 2011. It’s been mostly downhill ever since.
That brings us to Goldman’s latest move today.
Commodities as an asset class — relative to the stock market — are back down near where they were in 1998. I showed a chart on this last year.
Goldman’s move backs up this idea.
Commodities are hated — and cheap.
Bear in mind I’m discussing this from the perspective of the largest capital market in the world: The United States.
Australia’s mining industry has rebounded quite strongly since the distress of 2016.
It’s also been beefed up thanks to the drop in the Aussie dollar — an advantage its American peers don’t have.
However, around the world, the level of investment going into mining projects is much less than the go-go years before 2008.
BHP and Rio Tinto are an example of this. They remain extremely prudent around allocating capital.
Here’s the point: Bull markets are born in bear markets.
At some point, this underinvestment is going to bite — and drive prices higher.
But you can wait a long time for this to happen…
Filter the market this way
For example, I keep reading and hearing how copper has seen a huge surge in demand coming from electric cars.
But the price of copper is down on the high of 2018…and miles off the giddy heights of 2011.
But there’ll be another copper boom in the future. The boom-bust cycle won’t stop.
There are two approaches you can take around an idea like this.
One is to grab a stake in a long-life, low-cost copper miner while sentiment is down and profits are modest.
You put it away and plan to hang on for years, come what may.
The problem is that you tie up precious capital in a stock with no momentum and it can go sideways — or, worse, down — for years.
A second approach is to wait for a signal from the market to try and time your entry.
I’ve found a useful signal for commodities is to see if multiple stocks in the same industry start moving into new highs.
That suggests something broad based is happening. I don’t see any copper stocks doing this currently.
So I watch developments with interest — but don’t act on anything as yet.
However, it’s another reason I remain positive about the outlook for Aussie stocks in general.
Goldman Sachs’ exit certainly suggests the commodity bear market is closer to finishing than starting…and prices could rebound sooner than we think.