December 13, 2006– I remember a King of the Hill Episode (an American TV show) where the main character asks his Laotian neighbor, “Are you Japanese or Chinese?” The neighbor answers, “Laotian”, to which the Caucasian character immediately replies, “So. Are you Japanese or Chinese?” As I’m recalling this from memory, that might not be the exact transcript, but it’s very close. Although this episode was poking overt fun at the often-joked about inability of some Caucasians to distinguish among the many different Asian ethnicities, and the consequent marginalization of all Asians to either the category of Chinese or Japanese, too often in economic discussions, all of Asia is lumped together as well. 
“The Asian Economy” is discussed as if there is no distinction between the economies of Japan, China, Korea, India, Singapore, Hong Kong, Thailand, Vietnam and so on. And for good measure, sometimes the region is discussed as “the Pacific Rim” so the Australian and New Zealand economies can be thrown in for good measure. Commodities are the same.
Even Chief Economists at global investment firms continuously blunder by speaking of commodities as if they were one homogeneous group. Sometime around this past September, Stephen Roach, the Global Economist for Morgan Stanley, stated, “For the second time in five months, commodity markets are coming under serious selling pressure. I don’t think this is a fluke.” He went out to clarify this statement by clearly outlining his opinion that “the commodities bull market” was done, cooked, over. The only problem with this statement is that “commodities” cover a wide variety of different products including wheat, corn, cocoa, soybeans, sugar, orange juice, pork bellies, natural gas, coal, ethanol, crude oil, gold, silver, copper, platinum, steel, zinc, and so on. To lump them all together as if they had a perfect correlation coefficient of 1.0 is maddening.
Since Stephen Roach’s comment, just within the past four months, I’ve entered into an asset class that is most definitely a commodity with about six positions. The smallest gain I’ve made over the past four months with this commodity has been about 38% while most of my positions are up 50%, 60%, and even 85% and higher in just four months. And this doesn’t even take into account simlarly solid gains in gold stocks, though they’ve pulled back in the past week. But remember from last week’s newsletter, that this behavior in gold is exactly what I expected.
Furthermore, with certain oil and coal stocks, there certainly appears to be a fairly good risk-reward set-up now with a considerable upside much more likely than a considerable downside at least in the short-term. Corn and wheat, also commodities, have had very strong pushes higher as well, and seem positioned for strong future months. While it is true that small bumps higher during bear markets are common just as sharp corrections lower are common during bull markets, and that the energy sector is sure to see some volatility in the future as it decides what direction to head in, I still believe it is highly erroneous for people like Steven Roach to declare the bull market in commodities is over.
And while I still believe that a strong market correction in the U.S. is looming on the horizon, and is currently being driven by irrational behavior and the eternally optimistic bulls of most global investment firms as bullish optimism always serves their purposes of convincing more people to hand over more money to them, my above comments do not contradict this sentiment either. Even during general market corrections, it is possilbe for pockets of asset classes that perform well. But back to commodities.
Commodities covers far too diverse a group of assets for any blanket, one-size fits all statement to be accurate in any regard. As far as the stocks I like in the oil and coal sector for the next several months, there are plenty. While my best guess is that oil will moderate around $60 a barrel for the next year or so and not head anywhere close to $20-$40 a barrel as a whole handful of experts predicted once oil prices started sliding, there are still plenty of gains to be made in the next six months or so in this sector. The direction of oil is so difficult to predict because of so many moving parts, aka, the possibility of war in Iran that could shut down the Straights of Hormuz and send oil skyrocketing, political manipulations that send oil sliding, and OPEC decisions to cut back or increase production.
I’m going to pre-qualify the rest of this paragraph by stating that I haven’t yet researched in detail any of these companies, but from previous research I performed regarding sectors that should benefit in the near future (which I’ve already blogged about), I would consider companies like Acergy, Rowan, TransOcean, etc., smaller independent oil companies like Soco or Husky, and even an occasional major like Royal Dutch Shell that has been moderating back and forth for the past year or so. As far as coal, this sector for the short term for this sector looks even better than oil service companies. Two companies that I looked at briefly that seem to have all negativity already built into their share price and could experience a nice short-term bump are Fording Coal (due to the recent royalty trust taxation controversy), a Canadian company and Puda Coal, a Chinese one.
In any event, the important lesson to take away from this is, commodities, like Asians, are not a homogeneous group. Just because some “expert” out there says the commodity bull run is over does NOT mean that you can’t still make good money in commodities as each subsector must be examined for its current upside potential and downside risks.
I’ve been silent for a little bit so given that there is a strong analogy here to martial arts, I’m going to raise my voice today. The same pet peeve, J.S. that you have about how commodities, Asians, and regional economic markets are often discussed, I have about martial arts.
People tend to lump martial arts into one category, not understanding that there are linear art forms, circular art forms, hard styles, soft styles, defensive art forms, aggressive art forms, striking forms, grappling forms, eight-stepping forms, styles that may be better for times of youth and styles that are still applicable into old age, and so on. Those that truly don’t understand martial arts always claim that one style is superior to another. I’ve often heard jiu-jitsu practitioners claim that jiu-jitsu is the best martial art, but the fact is that every art form has its merits and its weaknesses.
It is a mistake to lump all martial arts into one category. Mixed Martial Arts, or MMA is all the rage today because martial arts practitioners have realized that they need both a strong stand-up game and a strong ground-fighting game to be a superior martial artist. They have learned to distinguish between the various nuances of different martial artists and learn different styles that suit their strengths.
Learning to identify the differences and subclasses that exist in stocks will also help you become a better investor. Too often in the media, people speak of commodities and energy stocks and healthcare as if there were no subclasses and divisions within these asset classes. If the run up in oil prices ends, maybe there is still great opportunity in the oil pipeline-manufacturing sector, or with oil refiners, or with deep-sea rig manufacturers. If healthcare is on the rise again, maybe there is a niche sector that is growing much more rapidly such as small biotechnology companies or private nursing homes that would be a far better investment than the major pharmaceutical companies.
Learn to ignore media “investment speak” and to identify nuances within asset classes and you will immediately become a better investor.
Maholo,
Kaeho
__________________
J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.
