Commodities Funds Part Deux: Dumb Investment of the Week by Ben Strubel of Strubel Investment Management

4/7/2014

Recently, a nice man named George H. Rohrs Jr. from Price Asset Management, a firm that specializes only in commodities and managed futures investments, emailed me a copy of the newsletter his firm sent to clients in which he wrote a response to my article on commodity funds. Mr. Rohrs asserted:

I wouldn’t call Ben Strubel, the author of this article “stupid.” I would just call him “ignorant” and “unprofessional” and “biased.” I just believe that he ought to get his facts straight before embarrassing himself by publishing the compendium of misinformation contained in his article.

I wouldn’t call Mr. Rohrs an expert in the usage of quotation marks but I would call him a man with some very strong opinions about me. Let’s look at the points he raises in his article and find out if I am in fact ignorant, unprofessional, and biased. Okay. I’m currently sitting in my office not wearing my shoes, so I’ll cop to the unprofessional part.

Before we find out if I’m ignorant, I want to explain what my business is and how I am compensated. My firm is a registered investment advisor, and we provide fee-only wealth management services to clients. We charge a flat 1% of assets per annum for portfolios we manage. Notwithstanding our 401(k) advisory business and hourly consultation engagements, we get paid 1% of client assets no matter what investments we make for the client. If we bought stocks, bonds, mutual funds, ETFs, index funds, actively managed funds, domestic stock, international stock, penny stocks, or mega cap stocks, the client still pays us 1%, no matter what. If we bought commodity stocks or commodity funds for clients, then we would still make 1%. Even if we invested client money with Mr. Rohrs’ firm, we would still charge 1%. So we are the very definition of unbiased. Our only goal is to manage client investment portfolios to help clients meet their financial goals. It’s in our best interest to choose the best possible investments, no matter what they are, for inclusion in client portfolios. I’m not sure how it is possible for me to be biased in the investment selections we make for clients as I have no personal financial incentive to choose one investment over the other.

Now, let’s investigate whether or not I’m ignorant. Let’s go through some of Mr. Rohrs’ arguments.

His first point is excerpted below (emphasis his):

He [Ben Strubel] says that the idea of investing in commodities for price appreciation understates the ability of humans to simply come up with alternatives and improved technology to produce more. He gives specific examples via charts, in the article, showing how the yields per plant on corn and soybeans have increased dramatically over the years.

In response, I would call Mr. Strubel’s attention to remarks made by David Hightower, publisher of the widely followed Grains publication, the Hightower Report, at a presentation at the Chicago Mercantile Exchange on June 27, 2013 just before a USDA Update Report on Grains production and inventories. Here is what I wrote then.

“I attended a presentation at the Chicago Mercantile Presentation, this afternoon, on the subject of tomorrow’s USDA Acreage Report on Grains.

“A major reason I wanted to attend was because David Hightower, publisher of the Hightower Report, was listed as one of the presenters. I believe the Hightower Report to be the best commodities’ research published. Another member of his team gave their specific outlook for tomorrow’s USDA Report. However, Mr. Hightower took the opportunity to share with the audience a dramatic conclusion that he has come to. He said, ‘I am convinced that we are near a major commodities bottom across the board.’ With regard to Grains, he asked the audience ‘to consider that the world has had five consecutive years of record grain production, and that inventories are at 40 year lows. What does that tell you?’ he asked.”

“Mr. Hightower said he was in China recently and that their consumption of commodities is and will continue to be “voracious.” As an example, he showed a graphic of the pig population in countries around the world. China has 446 million pigs. The second largest number was in the United States with 66 million. New car registrations in China now considerably exceeds the U.S.”

David Hightower has likely forgotten more about grain production than Ben Strubel ever knew.

I’m not entirely certain what his point is. If it is that David Hightower knows more about grain production than I do, I would have to assume that is correct. At the risk of putting words in someone’s mouth, I’m going to make the assumption that Mr. Rohrs’ thinks my assertion that investing in commodities is a bet against human ingenuity and that improved mining and agricultural techniques will allow commodity production to keep pace with demand is incorrect.

Below is yet another chart that shows human innovation increasing supply. The chart below shows the yield (in kg) per hectare for cereal production (soy, maize, wheat, rice, barley, oats, etc) in the world from 1967 to 2012.

Commodities Funds

Cereal yields have gone from about 750kg/hectare to well above 3500kg/hectare. As demand for commodities increases, so too does the technology and innovation allowing ever more of them to be produced.

The issue is whether or not supply is meeting demand. Here again the answer is obvious. For decades commodity prices have tracked demand. Only with the advent of the “indexing era” and the flow of over $300B in speculative assets in to the commodity markets have prices become unhinged from demand.

Commodities Funds - 2

(Graph source: Thompson Reuters)

The huge spike in commodity prices has not come from increased demand. As you can see from the graph, world industrial production (a good proxy for commodity demand) is increasing but not at a pace to justify current commodity prices.

We also have the issue of substitution. If one resource becomes scarce, then it is possible to substitute a different resource. Assuming that the demand for one particular commodity will not fall and that substitutes will not be found seems strange.

Mr. Rohrs then says:

Also, Mr. Strubel claims commodities over the long-term have produced no real return. The RICI started trading in August 1998. If you look at the attached graphics, you will see that since that date, through January 2014, the RICI’s Total Return has been 250 percent versus that for the S&P 500 at 112 percent. Also, if you look at the attached table ranking all the investment indices on the Barclay Hedge database, over that period, you will see that the RICI has outperformed most of the indices, whether stocks, bonds or hedge funds.

That brings us to my assertion that Mr. Strubel’s reporting is “biased” and “unprofessional.” He cites the example of the NYSE shares tracking the Rogers International Commodity Index, called “Elements” as the worst performing commodities fund investment there is, down -20 percent since inception. What Mr. Strubel fails to point out is that the Elements shares only began trading in November of 2007, just before the sub-prime markets crash

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