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Saturday, January 29, 2011

Why Natural Resource assets is better investment than US Bonds

My friend John Chinnock posted his view why US bonds are the safest place to invest in this time of economic uncertainty back in October 2010. I have been thinking of a response since then, like a second job perpetually coming to the forefront as I stole bits of time out of my life. My poor wife sometimes has to deal with my focus drifting to the ether of thought of global financial doom. Hopefully I can soon put this blog to bed, as I brain dump the culmination of my learning the last 4 years about world financial pressures, peak oil, natural resource problems, and global demographics.
The truth is, my time would be better spent focusing on two items, my job and my family. I need to keep an eye on the financial picture, but at a healthier distance. My goal is to reduce time spent to 4 hours on a Sunday night, to update my view. Watching each step daily is counterproductive to my immediate financial wellness and happiness.
So this post is a step closer to bring my view to an articulated summation, culminating with key metrics to watch over time. My goal is to stick to these key metrics, and provide periodic updates as I burn those Sunday night hours.
On to why Natural Resources is the right choice for investing.
Global Economic shift
The USA has about 300 million people and is by far the largest consumer of world resources. It is dependent on energy from foreign sources, manufactured goods from china, and food from south America. The consumption of Americans has become a surreal iconic image in the world view. I am part of this iconic image, being a fat, over-consuming, indulgent American. I haven’t taken an oath of poverty, and I have benefited from this resource consumption imbalance.
But times are a changing. China and India have about 2.5 billion people compared to the US at 300 million. I believe the goal of Reagan back in 80’s was to awaken this demographic in a hopes to help perpetuate global growth. I suspect his administration first spotted the demographic imbalance ahead as I described in my post titled “Demographics is driver to economic growth”.
I am of the belief that the awakening of the economies of these two countries will forever change the future of American’s quality of life. I have posted this already on why, please see post “China V America” on why.
The upshot is, as China and India population grows with improved economic wealth, the US cannot possibly maintain the same percentage of world resource consumption. I don’t think it is a far stretch to expect 2.5 Billion people to consume more than 50% of all resources produced. Heck, I could see those countries DEMANDING 90% of the world resources, as economic powerhouses of consumption, taking the crown away from the 300 million US citizens.
Whatever the evolution of resource consumption is, I can’t imagine it will be good for Americans lifestyle. For the consumption of fewer resources will come in the form of more expensive resources. After all, I doubt Americans will consume less, if they can afford more!
The question then becomes what resources to invest in? Frankly, here you should apply your own thought and seek advice other than me. However, I can’t help but give my spin.
OilPeak oil is real and is here. The concept is the wells pulling out of the ground are continuously decreasing in volume produced. This is a fact of all oil wells. Historically, the world has started new wells to keep up with this decline in oil production, and to exceed total output. But the problem is the larger wells are accelerating in the decline. New oil isn’t cheap to get. It has to be in more expensive areas to pull, like in the deep sea. It also may not be as “clean” and need more processing. Two critical facts will make oil more expensive to produce and demand is not curbing. Already America is demanding more oil than the economic peak of 2007! China and India are unstoppable forces of increasing consumption. This race to consume more will soon hit the wall of production, oil at 300 a barrel in USD will be seen in the next 10 years. Maybe 2011? Who knows.
Energy in general – Due to peak oil, investments in alternative energy, natural gas, coal, nuclear, and other related industries are all good. As oil becomes more expensive, other energy becomes more viable and will be consumed more as shift way from oil becomes required.
Precious Metals – I have blogged many times, I do not believe gold is money. I therefore do not like gold as an alternate currency. It is frankly, insanity. Gold as money works in a mad-max world. I will not spend my life planning for mad-max. However India and china cultures are in love with gold. As 2.5 billion people can afford to spend more disposable income, one common theme in both cultures is buy gold! And of course, the alternate reason is there are plenty of people who do view gold as money. For whatever the reasoning of people purchasing, I expect gold gold gold to the moon. I can easily see gold at 5,000 an ounce in US dollar terms. Silver and others are in the same boat, but for just simple reason that as India and china grow economically, demand will rise for all resources, including silver.
Mind you, the road may include a gold price collapse, for it is the ultimate ponzi scheme. If the world financial markets fall, I could see gold hitting 1,000 an ounce. I doubt we’ll see it fall any lower, as the buyers in such a fear market will step up, as they did in 2008 at around 800 an ounce.
For in times of fear, people buy what they know as a value store, rather than what they don’t know.

Food – Food embargoes where experienced in the 2008-2009 economic crisis. Once the flow of funds and credit dried up, countries where quick to cut off exports on food needed to feed their own populous. The world inter-dependant on feeding each other is a precarious situation. The moment food is viewed as a critical resource to keep a population happy, exports will be cut like a chain reaction.
Example, Americans gets its fruits from south America in the winter. If the supply is cut off for whatever reason, Americans may need to cut exports of their excess winter food production to other countries to stock shelves with alternate nutrition. This could cause a chain reaction and crisis. Luckily America is well positioned, as we net produce more food than we consume. We may need to go on a diet, but I don’t think we will go hungry as a nation.
The tight food supply combined with bizarre weather patterns continuing to evolve, and food storage reaching unprecedented lows by world governments, has placed the global food chain in a precarious position. A decade ago large food deposits had to be kept in the food chain, minimizing price shocks due to supply disruptions. With advancements in shipping and computerization, the food chain is more real time and can amplify crisis costs.
Rare Earth Elements – Although akin to precious metals, rare earth elements deserve their own category. Rare earth elements are materials mined that are located in very limited known locations. Currently China manufactures about 95% of the global rare earth elements. In an attempt for China to control world manufacturing, and to keep internal resource costs down, China has announced limited quotas for exporting rare earths. Further, China has used exporting rare earths as a political weapon against Japan, to in essence blackmail the Japanese government to comply with Chinese desires.
Rare earth elements are used to make solar panels, ipads, some cell phone components, some batteries, and many high tech items today. Companies have announced plans to re-architect manufacturing to use alternative materials than rare earths to minimize the grip China has. That is easier said than done. Some things in life cannot be made any other way (for practical use) than a specific material. Try to build a house without wood or plastics or make a computer chip without silicone. It can be done, but it may not be practical or economically affordable. I’m sure its possible, I’ll check back in 30 years to see how progress is going on your project. Point is, to simply state the world can work around this issue is na├»ve. Rare earths will continue to grow as a critical resource for high tech solutions. There are new mines being built in reaction to the reality the world has realized it is in. I for one am watching a stock called AVL. If it hits 5 bucks again, I may do some crazy buying and be a core position.
At a high level, rare earths used 100 years ago… I doubt anything worth recognizing. Last year? The threat of not getting rare earth materials to Toyota for their electric cars was enough to cause the Japanese government to cave to China’s will. The use of rare earths are on a upswing, an I believe, we are witnessing its infancy of recognition of the materials importance.
Currency - As several recent posts have articulated, America is playing a very dangerous game with it's currency. Currency valuation is faith based (fiat). So by definition of a fiat currency the majority believe the USD is stable, and not headed for a crisis. And typically the majority are on the wrong side of investments. As a fiat currency, faith in the USD must remain strong to maintain value. Hussman funds has in detailed describe the toxic financial chaos, the USD is poised for devaluation due to currency abuse. I have posted how the Federal Reserve Bank, a private institution may tap US tax dollars to cover it's losses, circumventing the constitution. Also how US Bonds is based on a mathematically proven model that cannot be sustained, based on exponential growth. Logic above aside, the indicator I am watching for USD trouble is when US bond rates breaks the trend established in 1985. A canary in the coal mine may be Japan, as their credit rating is starting to degrade, as their debt levels approach taking the crown in the world.
Please keep in mind, my view may be a little slanted, as I see currency needs a rebirth, away from asset (gold), or Fiat, to a new, more pure system. This reality will occur as computer systems assault the current people based currency system , responding quicker and more violently than can they can react to. Technology will break the current system and require a new monetary system as the fundamental flaws become exposed. It is possible to save the existing system, if rule of law returns and the system is made whole again. I doubt this will occur without a crisis.
Goal
The goal of choosing resources isn’t to become a multi-billionaire, although that is possible in any investing, worse odds than buying a mega-millions lottery ticket. The goal is to maintain purchasing power for your lifestyle. Natural resources are needed by everyone. And investing in companies related to natural resources tend to have an amplified effect on their earnings. For the companies valuation isn’t just about their production and sales THIS year. It is also forward looking on all the resources in the ground they have rights to yet produce. Their valuations can soar as a multiplication effect of the price of fossil fuels, precious metals, and rare earth minerals. Food isn’t likely to have any amplification effect, but could have some crazy spikes.
Summary
So to invest in the future of a economic growing world, I can’t see how natural resources across the entire spectrum of energy, food, precious metals, and rare earths, can be a loser over the next 10 years. And if we do arrive at some sort of mad-max world financial crisis, natural resources are always needed. I can’t say the same for UGG boots or US bonds.
As an added bonus, if the USD does suffer from loss of faith as a currency, which I do view as not likely in the next 2 years, being in natural resources protects purchasing power.
So whether resources go up in price in reaction to currency problems or just plain demand, I would find it impossible to flip from bonds to oil at 200 a barrel or gold at 3,000 an ounce. The charts would look like its over-priced ready for crash. I would be like a deer in headlights unable to move out of bonds. For this reason, I recommend everyone have a core position in natural resources across all areas while prices are in historical ranges. Everyone has to decide what they are comfortable with, 25%? My goal is 75% in natural resources or more.
For the remaining investments, please consider fixed income CD's, please see post Best Strategy for Fixed Income Savings for more information.
In another post, I’ll assemble ETF’s and individual players worth considering in each sector.

2 comments:

  1. Thanks for the thoughtful insight without the extreme, toxic Gloom & Doom behind so many peoples reasons for Gold, etc. I totally agree with your observations on peak oil and rare earths.

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  2. Thanks! Its tough to keep a level head with so many jumping to mad-max. I have a hard time not jumping to it myself. :)

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