Many investors think commodities are too risky. It makes sense when you look at the history…
Before the 2008 recession, oil was nearing $150 a barrel. Then it fell to the rock-bottom price of $35. Copper approached $1.20 per pound from a high of $4 six months earlier. Even gold — supposedly a “safe haven” that investors could turn to in tumultuous times — fell, to $750 per ounce from nearly $1,000 two months prior.
People thought they were safe by diversifying into commodities… But in a recession as deep and wide-ranging as 2008 was, everything went down. Especially commodities.
But to think commodities are too risky to invest in is a major mistake. Don’t get me wrong, commodities — and the companies that dig them up or process them — are still sensitive to boom-and-bust cycles.
Look at the peaks and valleys you see in the chart below:
I can understand why investors would want to avoid the ups and downs of commodities. But just because commodities go through boom-and-bust cycles doesn’t mean there is no place for commodity stocks in even the most conservative portfolios.
Sure, the industry has a reputation for risk, precisely because history tells us that what has gone up will eventually go down. This also implies that what has gone down will eventually go up.
So that’s where I look for commodities stocks — I zero in on what is down.
By focusing our investments in such sectors, we can reduce our risk of losses in the event of major financial problems — industries that are already beat up don’t have as far to fall during a crash.
We’ll also, ultimately, increase our chances for profit — either before or after the calamity we are trying to insure against.
So what is down right now? Where am I telling readers of my Scarcity & Real Wealth newsletter to make their next commodities investment? The answer is gold.
Gold fell about 35% between October 2012 and July 2013. But gold mining stocks — as measured by the PHLX Gold/Silver Sector (INDEXNASDAQ:XAU) — plummeted nearly 60% during the same period.
The price of gold fell about 30%, but the price of gold equities fell more than 55%
That’s a severe turn in investor sentiment — one that’s made precious metals equities a lot cheaper and, as a result, a lot less risky from the buy side.
The other reason I like the precious metals as a defensive play is that I believe prices for these metals should fare better than most other commodities during financial troubles.
Make no mistake — gold would sell off if we were to experience another 2008-like event. Speculative holders would be washed out of the market. But as we saw in 2008, that panic selling would be somewhat offset by panic buying — and gold rebounded faster than any other investment. By February 2009, the price of bullion was back to its pre-crash highs… and then went up from there.