commodities for dummies phần 2 potx

management competence, tax situation, debt levels, and profit margins, which have nothing to do with the underlying commodity. That said, invest- ing in companies that process commodities still allows you to profit from the commodities boom. Publicly traded companies The size, structure, and scope of the companies involved in the business are varied, and I cover most of these companies throughout the book. I offer a description of the company, including a snapshot of its financial situation, future growth prospects, and areas of operation. I then make a recommenda- tion based on the market fundamentals of the company. Here are the types of companies you’ll encounter in the book: ߜ Integrated Energy Companies: These companies, such as Exxon Mobil (NYSE:XOM) and Chevron (NYSE: CVX), are involved in all aspects of the energy industry, from the extraction of crude oil to the distribution of Liquefied Natural Gas (LNG). They give you broad exposure to the energy complex (see Chapter 11). ߜ Diversified Mining Companies: A number of companies focus exclusively on mining metals and minerals. Some of these companies, such as Anglo- American PLC (NASDAQ: AAUK) and BHP Billiton (NYSE: BHP), have oper- ations across the spectrum of the metals complex, mining metals that range from gold to zinc. I look at these companies in Chapter 18. ߜ Electric Utilities: Utilities are an integral part of modern life because they provide one of life’s most essential necessities: electricity. They’re also a good investment because they have historically offered large divi- dends to shareholders. Read Chapter 13 to figure out whether these companies are right for you. This list is only a small sampling of the commodity companies I cover in these pages. I also analyze highly specialized companies, such as coal mining companies (Chapter 13), oil refiners (Chapter 14), platinum mining compa- nies (Chapter 15), and purveyors of gourmet coffee products (Chapter 19). Master Limited Partnerships Master Limited Partnerships (MLPs) invest in energy infrastructure such as oil pipelines and natural gas storage facilities. I’m a big fan of MLPs because they’re a publicly traded partnership. This means they offer the benefit of trad- ing like a corporation on a public exchange, while offering the tax advantages of a private partnership. MLPs are required to transfer all cash flow back to shareholders, which makes them an attractive investment. I dissect the struc- ture of MLPs in Chapter 6 and introduce you to some of the biggest names in the business so you can take advantage of this unique investment. 17 Chapter 1: Investors, Start Your Engines! An Overview of Commodities 05_049286 ch01.qxp 10/26/06 2:58 PM Page 17 Managed funds Sometimes it’s just easier to have someone else manage your investments for you. Luckily, you can count on professional money managers that specialize in commodity trading to handle your investments. Here are a few options: ߜ Mutual funds: If you’ve previously invested in mutual funds and are comfortable with them, look into adding a mutual fund that gives you exposure to the commodities markets. A number of funds are available that invest solely in commodities. I examine these commodity mutual funds in Chapter 6. ߜ Exchange Traded Funds (ETFs): ETFs are an increasingly popular invest- ment because they are managed funds that offer the convenience of trading like stocks. A plethora of ETFs that track everything from crude oil and gold to diversified commodity indexes, have appeared in recent years. Find out how to benefit from these vehicles in Chapter 6. If you have a pet or a child, sometimes you hire a pet sitter or baby sitter to look out after your loved ones. Before you hire this individual, you interview them, check their references, and examine their previous experience. Once you’re satisfied with their competency, you entrust them with the responsi- bility of looking out after your cat, daughter, or both. Same thing applies when you’re shopping for a money manager, or money sitter. If you already have a money manager you trust and are happy with, then stick with him. If you’re looking for a new investment professional to look out after your invest- ments, you need to investigate her as thoroughly as possible. In Chapter 6, I examine the selection criteria you should use when shopping for a money manager. Physical attractiveness The most direct way of investing in certain commodities is by actually buying them outright. Precious metals such as gold, silver, and platinum are a great example of this. As the price of gold and silver has skyrocketed recently, you may have seen ads on TV or in newspapers from companies offering to buy your gold or silver jewelry. As gold and silver prices increase in the futures markets, they also cause prices in the spot markets to rise (and vice versa). You can cash in on this trend by buying coins, bullion, or even jewelry. I pre- sent this unique investment strategy in Chapter 15. 18 Part I: Commodities: Just the Facts 05_049286 ch01.qxp 10/26/06 2:58 PM Page 18 This investment strategy is only suitable for a limited number of commodi- ties, mostly precious metals like gold, silver, and platinum. Unless you own a farm, keeping live cattle or feeder cattle to profit from price increases doesn’t make much sense. And I won’t even mention commodities like crude oil or uranium! Checking Out What’s on the Menu I cover 32 commodities in the book. Here is a listing of all the commodities you can expect to encounter while going through these pages. While the book is modular in nature, I list the commodities in this list in order of their appearance in the text. Energy Energy has always been indispensable for human survival and also makes for a great investment. Energy, whether fossil fuels or renewable energy sources, has attracted a lot of attention from investors as they seek to profit from the world’s seemingly unquenchable thirst for energy. I present in this book all the major forms of energy, from crude oil and coal to electricity and solar power, and show you how to profit in this arena. ߜ Crude oil: Crude oil is the undisputed heavyweight champion in the commodities world. There are more barrels of crude oil traded every single day (85 million and growing) than any other commodity. Accounting for 40 percent of total global energy consumption, it pro- vides some terrific investment opportunities. ߜ Natural gas: Natural gas, the gaseous fossil fuel, is often overshadowed by crude oil. It is nevertheless a major commodity in its own right, which is used for everything from cooking food to heating houses during the winter. I also take a look at the prospects of Liquefied Natural Gas (LNG). ߜ Coal: Coal accounts for over 20 percent of total world energy consump- tion. In the United States, the largest energy market, 50 percent of elec- tricity is generated through coal. Because of abundant supply, coal is making a resurgence. ߜ Uranium/Nuclear power: Because of improved environmental standards within the industry, nuclear power use is on the rise. I show you how to develop an investment strategy to capitalize on this trend. 19 Chapter 1: Investors, Start Your Engines! An Overview of Commodities 05_049286 ch01.qxp 10/26/06 2:58 PM Page 19 ߜ Electricity: Electricity is a necessity of modern life, and the companies responsible for generating this special commodity have some unique char- acteristics. I examine how to start trading this electrifying commodity. ߜ Solar power: Due to a number of reasons that range from environmental to geopolitical, demand for renewable energy sources such as solar power is increasing. ߜ Wind power: Wind power is getting a lot of attention from investors as a viable alternative source of energy. ߜ Ethanol: Ethanol, which is produced primarily from corn or sugar, is an increasingly popular fuel additive that offers investment potential. There are other commodities in the energy complex, such as heating oil, propane and gasoline. Although I do provide insight into some of these other members of the energy family, I focus a lot more on the resources I men- tioned in the previous list. Metals Metallurgy has been essential to human development since the beginning of time. Societies that have mastered the production of metals have been able to thrive and survive. Similarly, investors that have incorporated metals into their portfolios have been able to generate significant returns. I cover all the major metals, from gold and platinum to nickel and zinc. ߜ Gold: Gold is perhaps the most coveted resource on the planet. For cen- turies, people have been attracted to its quasi-indestructibility and have used it as a store of value. Gold is a good asset for hedging against infla- tion and also for asset preservation during times of global turmoil. ߜ Silver: Silver, like gold, is another precious metal that has monetary applications. The British currency, the pound sterling, is still named after this metal. Silver also has applications in industry (such as electri- cal wiring) that places it in a unique position of being coveted for both its precious metal status and its industrial uses. ߜ Platinum: Platinum, the rich man’s gold, is one of the most valuable metals in the world, used for everything from jewelry to the manufactur- ing of catalytic converters. ߜ Steel: Steel, which is created by alloying iron and other materials, is the most widely used metal in the world. Used to build everything from cars to buildings, it’s a metal endowed with unique characteristics and offers good investment potential. 20 Part I: Commodities: Just the Facts 05_049286 ch01.qxp 10/26/06 2:58 PM Page 20 ߜ Aluminum: Perhaps no other metal has the versatility of aluminum; it’s lightweight, yet surprisingly robust. These unique characteristics mean that it’s a metal worth adding to you portfolio, especially since it’s the second most used metal (right behind steel). ߜ Copper: Copper, the third most widely used metal, is the metal of choice for industrial uses. Because it’s a great conductor of heat and electricity, its applications in industry are wide and deep, which makes this base metal a very attractive investment. ߜ Palladium: Palladium is part of the platinum group of metals and almost half of the palladium that’s mined goes towards building automobile cat- alytic converters. As the number of cars with these emission-reducing devices increases, the demand for palladium will increase as well, which makes this an attractive investment. ߜ Nickel: Nickel is a ferrous metal that is in high demand because of its resistance to corrosion and oxidation. Steel is usually alloyed with nickel to create stainless steel, which assures that nickel will have an impor- tant role to play for years to come. ߜ Zinc: The fourth most widely used metal in the world, zinc is sought after for its resistance to corrosion. It is used in the process of galvaniza- tion, where zinc coating is applied to other metals, such as steel, to prevent rust. Agricultural products Food is the most essential element of human life, and the production of food presents solid money-making opportunities. In Commodities For Dummies, you find out how to invest in the agricultural sector in everything from coffee and orange juice to cattle and soybeans. ߜ Coffee: Coffee is the second most widely produced commodity in the world, in terms of physical volume, behind only crude oil. Folks just seem to love a good cup of coffee, and this provides good investment opportunities. ߜ Cocoa: Cocoa production, which is dominated by a handful of countries, is a major agricultural commodity, primarily because it is used to create chocolate. ߜ Sugar #11: Sugar is a popular food sweetener and it can be a sweet investment as well. Sugar #11 represents a futures contract for global sugar. 21 Chapter 1: Investors, Start Your Engines! An Overview of Commodities 05_049286 ch01.qxp 10/26/06 2:58 PM Page 21 ߜ Sugar #14: Sugar #14 is specific to the United States and it is a widely traded commodity. ߜ Frozen Concentrated Orange Juice — Type A: FCOJ-A, for short, is the benchmark for North American orange juice prices, as it’s grown in the hemisphere’s two largest regions: Florida and Brazil. ߜ Frozen Concentrated Orange Juice — Type B: FCOJ-B, like FCOJ-A, is a widely traded contract that represents global orange juice prices. This contract gives you exposure to orange juice activity on a world scale. ߜ Corn: Corn’s use for culinary purposes is perhaps unrivaled by any other grain, which makes this a potentially lucrative investment. Check out how to trade it in Chapter 20. ߜ Wheat: According to archaeological evidence, wheat is one of the first agricultural products grown by man. It is an essential staple of human life and makes for a great investment. ߜ Soybeans: Soybeans have many applications, including as feedstock and for cooking purposes. The soybean market is a large market and pre- sents some good investment opportunities. ߜ Soybean oil: Soybean oil, also known as vegetable oil, is derived from the actual soybeans. It’s used for cooking purposes and has become popular in recent years due to the health-conscious dietary movement. ߜ Soybean meal: Soybean meal is another derivative of soybeans that’s used as feedstock for poultry and cattle. It may not sound sexy, but it can be a good investment. ߜ Live cattle: For those involved in agriculture, using the live cattle futures contract to hedge against price volatility is a good idea. ߜ Feeder cattle: While the live cattle contract tracks adult cows, the feeder cattle contract is used to hedge against the risk associated with growing calves. This area is not widely followed in the markets, but it’s important to figure out how this market works. ߜ Lean hogs: They may not be the sexiest commodity out there, but lean hogs are an essential commodity, which makes them a good trading target. ߜ Frozen pork bellies: Frozen pork bellies are essentially nothing more than good old bacon. This is a cyclical industry subject to wild price swings, which provides unique arbitrage trading opportunities. 22 Part I: Commodities: Just the Facts 05_049286 ch01.qxp 10/26/06 2:58 PM Page 22 Benefiting from Commodities Creatively While I was researching this book, I came across a number of colorful charac- ters, both in-person and in historical accounts. One such character was Samuel Brannan, who lived during the 1848 California Gold Rush. The story of Sam Brannan is not well known but it is astonishing nevertheless and pro- vides insight into how to approach the markets. Sam was the third person to find out that gold had been discovered in California. The first two people with this knowledge — John Sutter and James Marshall — wanted, for obvious reasons, to keep this discovery secret. Sam Brannan, who eventually profited so much from the gold rush that he became California’s first millionaire, got rich without digging a single hole or prospecting for a single nugget of gold. How did he do this? By selling shovels! When Sam, who owned a convenience store in Sutter’s Fort near the gold deposits, heard that gold had been discovered, he quietly went around north- ern California and bought all the shovels, picks, and pans he could get his hands on. After he cornered this market, he literally went around town screaming at the top of his lungs, “We found gold! We found gold!” Once word spread that gold had been discovered, a swarm of people came to northern California, all wanting to dig for gold, and Sam was the only man in town to sell them the shovels. Sam Brannan’s story shows that you can profit from the current commodities boom — which is similar to the California Gold Rush in more ways than one — by being creative. You don’t have to invest in just crude oil or gold futures contracts to benefit. You can trade ETFs, invest in companies that process commodities such as uranium, buy precious metals ownership certificates, or invest in Master Limited Partnerships. The commodities markets are global in nature, and so are the investment opportunities. My aim in this book is to help you uncover these global opportunities and to provide you with the investment ideas and tools to help you unlock and unleash the power of the commodities markets. 23 Chapter 1: Investors, Start Your Engines! An Overview of Commodities 05_049286 ch01.qxp 10/26/06 2:58 PM Page 23 24 Part I: Commodities: Just the Facts 05_049286 ch01.qxp 10/26/06 2:58 PM Page 24 Chapter 2 Earn, Baby, Earn! Why You Should Invest in Commodities In This Chapter ᮣ Looking at recent performance ᮣ Profiting from global economic trends ᮣ Examining the unique characteristics of commodities ᮣ Investing in commodities across the business cycle C ommodities have traditionally been considered the black sheep in the family of asset classes — no one wanted anything to do with them. This traditional lack of interest (which no longer applies, by the way) has gener- ated a lot of misinformation about commodities. As a matter of fact, probably no other asset class has suffered through so much misunderstanding and misconception. A lot of investors are, quite frankly, scared of venturing into the world of com- modities. For one thing, it seems that every time the word “commodities” is uttered, someone pops up with a horrible story about losing their entire life savings trading soybeans, cocoa, or some other exotic commodity. Even though this negative perception is rapidly changing, commodities are still often misunderstood as an investment. I actually know some investors who invest in commodities (and who have made money off them) but who don’t understand the fundamental reasons why commodities are such a good long-term investment. (Yikes!) 06_049286 ch02.qxp 10/26/06 2:59 PM Page 25 In this chapter, I show you why commodities are an attractive investment and why many investors are becoming more interested in this asset class. I also give you the goods on a number of global trends that are responsible for the recent run-up in commodity prices. Those who are able to spot these trends are going to do extremely well. And those who don’t, well, I wouldn’t want to be in their shoes! You Can’t Argue with Success In recent years, commodities as an asset class have received a lot of attention from the investor community. Many investors are turning to commodities because they are disappointed with the returns that other investments have offered and, more importantly, because commodities have performed extremely well recently. Take a look at Figure 2-1, which shows the recent performance of the Reuters/Jefferies CRB Index, an index that tracks a basket of commodities. 380 360 340 320 300 280 260 240 220 200 20000 10000 1998 1999 2000 Volume 1559.00 Open Interest 1059.00 2001 2002 2003 2004 2005 Figure 2-1: Performance of the Reuters/ Jefferies CRB Index from 1997 to 2006. 26 Part I: Commodities: Just the Facts 06_049286 ch02.qxp 10/26/06 2:59 PM Page 26 [...]... York Mercantile Exchange (NYMEX) as shown in Figure 2- 2 has increased from $20 per barrel in 20 01 to over $70 in 20 06, an increase of 350 percent! 70 60 50 40 Figure 2- 2: The price of WTI Crude Oil (NYMEX) between Volume 4648873.00 Open Interest 890463.00 1997 and 20 06 (Dollars per Barrel) 1998 1999 20 00 20 01 20 02 30 20 5500000 3500000 20 03 20 04 20 05 The price of gold, another key commodity, has also... 28 Part I: Commodities: Just the Facts 650 600 550 500 450 400 Figure 2- 3: The price of Gold (COMEX) doubling between Volume 126 622 8.00 Open Interest 331 122 .00 1997 and 20 06 (Dollars per Troy Ounce) 1998 1999 20 00 20 01 20 02 350 300 1800000 1000000 20 03 20 04 20 05 Never invest in something you don’t understand If you hear someone on TV or the radio mention an investment, make sure you perform your due... gold, silver, and other commodities to provide you with financial safety For example, after the horrible acts of September 11, 20 01, the price of gold jumped as investors sought safety in the metal You can see a clear spike in the price of gold in Figure 2- 7 right after September 11 AM PM 300 29 5 Increased demand for gold on Sept 11 29 0 28 5 28 0 27 5 29 –Sep 30–Sep 27 –Sep 25 –Sep 23 –Sep 21 –Sep 19–Sep 17–Sep... aluminum produced in the world In 20 03, China overtook Japan to become the second largest consumer of crude oil — right behind the United States (For more information on global oil consumption, make sure you read Chapter 11.) In Figure 2- 6 you can see the expected Chinese consumption of crude oil for the first quarter of the century 20 15 10 5 0 20 01 20 10 20 15 20 20 20 25 CONSUMPTION PRODUCTION China is... hit a 26 -year high when it reached $730 a troy ounce in May 20 06 Check out gold’s recent performance in Figure 2- 3, as measured in the futures market Many investors, intrigued by the eye-popping performance of commodities, want in on the action However, a majority of investors are pouring into commodities without knowing why commodities are performing well — and this is a recipe for disaster 27 28 Part... 13 years in the 21 st century! This means the rate at which the human population is increasing has reached exponential levels Check out Figure 2- 4 for the expected population growth in the 21 st century PEOPLE ON THE PLANET Population (in billions) Figure 2- 4: Population growth in the 20 th and 21 st centuries 9 8 7 6 5 4 3 2 1 0 1950 1970 1980 20 10 20 30 20 50 So how is this relevant to commodities? Put... aluminum have experienced between 20 03 and 20 06 are a direct result of increased demand from China Chapter 2: Earn, Baby, Earn! Why You Should Invest in Commodities Figure 2- 6: China is expected to increase its consumption of crude oil products to approximately 12 Million Barrels a day by 20 25 Source: Energy Information Administration Barrels per Day in Millions For example, in 20 04 China gobbled up half... doesn’t perform well for them For example, during 20 00 and 20 01, the investing public lost a total of $5 Trillion in stocks (remember the bursting of the dot.com bubble?) And yet you never hear the kinds of warnings about stocks that you hear about commodities Is this a double standard? You can judge for yourself  42 Part I: Commodities: Just the Facts I believe that many investors are afraid of commodities. .. Figure 3-1: The 25 0 performance of commodities (as measured by the CRB Index) and equities (as measured by the S&P 500) 180 1,600 Standard & Poor’s 500 1,000 500 Reuters – CRB 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 90 49 50 Part I: Commodities: Just the Facts Managed funds: Another one (or two) bites the dust While I was writing Commodities For Dummies, the prices... Since the fall of 20 01, commodities have been running faster than the bulls of Pamplona The Reuters/Jefferies CRB Index (a benchmark for commodities) nearly doubled between 20 01 and 20 06 During this period oil, gold, copper, and silver all hit all-time highs (although not adjusted for inflation) Other commodities also reached levels never seen before in trading sessions Chapter 2: Earn, Baby, Earn! Why . 380 360 340 320 300 28 0 26 0 24 0 22 0 20 0 20 000 10000 1998 1999 20 00 Volume 1559.00 Open Interest 1059.00 20 01 20 02 2003 20 04 20 05 Figure 2- 1: Performance of the Reuters/ Jefferies CRB Index from 1997 to 20 06. 26 Part. ounce 03–Sep 05–Sep 07–Sep 09–Sep 11–Sep 13–Sep 15–Sep 17–Sep 19–Sep 21 –Sep 23 –Sep 25 –Sep 27 –Sep 29 –Sep 30–Sep 29 5 AM PM 29 0 28 5 28 0 27 5 27 0 26 5 Increased demand for gold on Sept. 11Increased demand for gold on Sept. 11 Figure 2- 7: Investors turn to gold for. sessions. 1000000 1800000 20 05 Volume 126 622 8.00 Open Interest 331 122 .00 20 0 420 0 320 022 00 120 0019991998 300 350 400 450 500 550 600 650 Figure 2- 3: The price of Gold (COMEX) doubling between 1997 and 20 06 (Dollars