Why Raw Materials?

Why Raw Materials?
by Jim Rogers (written in 2002)

Jim Rogers' New Book:
Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market

Natural resources influence a significant portion of the world economy. They are the largest “non-financial” market in the world. Many studies indicate raw materials price movements are not correlated to the price movements of financial instruments. This means a natural resource investment can provide important portfolio diversification. Earnings on a natural resource investment, despite a bear market, demonstrate the merits of having raw materials diversification for most portfolios. Who knows what might happen if there were ever a bull market in natural resources?!

Throughout history, there have been bull markets in raw materials every 20-30 years. Supply and demand regularly get out of balance, leading to recurring periods of rising (and declining) prices. Natural resources have been in a bear market for about 25 years now (e.g. sugar peaked in 1973, oil in 1981, etc.). Declining markets attract little in the way of increased productive capacity, and this bear market is no different. Virtually no one has built an offshore drilling rig, or opened a lead mine, or developed a sugar plantation during this period. Quite the opposite - productive equipment has deteriorated, been cannibalized, or scrapped while other capacity has closed.

Demand has continued to increase during this period of static and declining sources of supply. Prices have declined because of inventory liquidation. The stockpiles built up because of the carry-over, hoarding mentality, and the cold War have been liquidated leading to all-time low inventories on a stocks/consumption basis. For example, the percentage ratio of foodstuffs inventories to annual consumption reached records of about 35% in the 1980’s. The ratio is in the low teens now.

The recent desperate raw materials dumping by the Russians, at a time when Asia just stopped buying, has caused recent lows in many commodities. These lows may last for years. We may be seeing long term double and triple bottoms even if the world economy slows. Remember, the 1970’s saw tremendous rises in raw material prices, despite economic stagnation, as supply and demand corrected imbalances.

An occasional argument against natural resource prices ever rising again is “technology”. However, the world has had repeated dramatic breakthroughs throughout history, yet these breakthroughs have not prevented periodic, multiyear commodity bull markets. We have seen faster transportation, communication, and productive advancements before in railroads, steam ships, radio, telephone, electricity, planes, etc.. None kept prices down forever.

The hydrocarbon industry of the 1960’s and 1970’s is a recent example. In the mid-1960’s, drilling below 5,000 feet or offshore was almost impossible. An explosion of technological advancements led to 25,000-foot wells and offshore development world wide. The Hughes diamond bit drill led to unthinkable drilling efficiency. Yet oil prices rose 1,500% in that fifteen year period.

The Rogers International Commodities Index (RICI)* was designed to meet the need for consistent investing in a broad-based international vehicle. Thirty-five commodities are represented in the Rogers Commodity Index. This gives it breadth just as the S & P 500 is broader than the Dow Jones Industrials. International commodities are represented, whereas most other indices are regional or U.S.-oriented. For example, other indices exclude rice, the staple food of a large percentage of the world. All commodities in the Rogers International Commodity Index are publicly traded on recognized exchanges to insure ease of tracking and verification. The Rogers International Commodity Index does not include non-traded items such as hides or tallow, which are included in other popular indices.

The Rogers International Commodities Index attempts to balance consumption patterns worldwide. One popular index has 19% in precious metals with only 6% in hydrocarbons - the same weighting it gives orange juice. Another recently had as much as 63% in hydrocarbons, with only 37% for everything else the world consumes. The Rogers International Commodities Index is designed to offer stability - partly because it is broadly based and consistent in composition. Another popular index is changed dramatically every year, which does little for continuity.

In short, raw materials should always be represented in any diversified portfolio. Stocks, bonds, cash, and real estate do not provide sufficient representation of the world’s economy, nor sufficient non-correlation to each other.

One of history’s recurring raw materials bear markets may be currently ending, as supply and demand become unbalanced due to economic shifts. Raw materials inventories are now historically low. The Rogers Commodity Index was organized to meet a need in the financial spectrum currently not effectively covered.