In the Shadow of 1937

[DemonD]

Re: In the Shadow of 1937

I think history can be instructive, but we shouldn't try to impress the mould of the past fully on the present. I prefer to focus mostly on today's fundamentals...

Look at the S&P 500, for instance: while up supposedly near 14% on the year, it is actually only up a little over 5% when adjusted for the dollar's devaluation over the same time period.

You wouldn't want to have shorted that market, but on the other hand, your money would have been better allocated to gold and other natural resources/commodities (gold itself was up about 10% on the year with the same dollar devaluation adjustment).

This, IMO strengthens the the argument FOR stocks and equities, because the best way to stay ahead of inflation is to invest in the human capital of people who are out-producing inflation. With less tax hits, and less hassle of holding gold. Plus you can just buy gold-based equities, or other resource based equities. And while we want to look at the present, can you completely discount history? Stocks historically obliterate commodities. Plus, dividends, sweet, yummy dividends. And why not combine them all? Get a dividend-paying, commodity-based stock with above-average growth prospects, and you get the best of all worlds.

That, in any case, has been my own personal financial conclusion. Buy good commodity extracting and selling companies. (I still say oil is safer/better than gold, but that's my own preference. There has been enough evidence presented on itulip to convince me that gold is also excellent for investment.)

[Finster]

Re: In the Shadow of 1937

This, IMO strengthens the the argument FOR stocks and equities, because the best way to stay ahead of inflation is to invest in the human capital of people who are out-producing inflation. With less tax hits, and less hassle of holding gold. Plus you can just buy gold-based equities, or other resource based equities. And while we want to look at the present, can you completely discount history? Stocks historically obliterate commodities. Plus, dividends, sweet, yummy dividends. And why not combine them all? Get a dividend-paying, commodity-based stock with above-average growth prospects, and you get the best of all worlds.

That, in any case, has been my own personal financial conclusion. Buy good commodity extracting and selling companies. (I still say oil is safer/better than gold, but that's my own preference. There has been enough evidence presented on itulip to convince me that gold is also excellent for investment.)

Historically stocks have been the best inflation hedge, although the record is irregular. Over time, stock prices do track inflation, but fall behind during times of rising inflation and ahead during falling inflation. There is an effect at the level of the second derivative, so to speak. In contrst, gold actually has not fully kept up with inflation over time, but does tend to outperform during periods of rising inflation as well as falling behind during periods of falling inflation. They are thus both inflation hedges at the first derivative level but complementary at the second derivative level.

One reason for the difference is that stocks are securities which discount the value of future money. When inflation and interest rates rise, the discount increases. For that reason, gold itself (which does not discount future money) is a better complement to a portfolio of stocks and can easily outperform mining stocks when stocks as an asset class are doing poorly. This is not to argue against owning mining stocks, just against viewing them as a substitute for the real thing.

Commodity futures as a class also historically have provided returns comparable to stocks; over time they pay an additional return component over and above commodity prices themselves, somewhat analogous to the dividends paid on stocks. They also tend to exhibit a similar complementary characteristic to stocks as does gold with regard to the inflationary cycle, and are therefore useful portfolio diversifiers, especially in times of inflation.

[bart]

Re: In the Shadow of 1937

Stocks historically obliterate commodities.

Not to take away from any of your other points, but do be cautious on such a broad statement.



(note that the housing data has been extrapolated from very sparse data prior to 1963, and that the CRB data has been spliced with other commodity data from the NBER prior to 1956)

[Finster]

Re: In the Shadow of 1937

Not to take away from any of your other points, but do be cautious on such a broad statement.

You are both right. The gap lies in that DemonD is probably referring to pure commodity prices, which are widely outpaced by stocks. Commodity futures, on the other hand, over time have been shown to be capable ot providing returns comparable to stocks. This is because of a number of additional attributes such as "roll yield", and the "insurance" component the futures investor provides. This has been discussed in depth by researchers such as Gary Gorton and K. Geert Rouwenhorst, in Facts and Fantasies about Commodity Futures.

[bart]

Re: In the Shadow of 1937

You are both right. The gap lies in that DemonD is probably referring to pure commodity prices, which are widely outpaced by stocks. Commodity futures, on the other hand, over time have been shown to be capable of providing returns comparable to stocks. This is because of a number of additional attributes such as "roll yield", and the "insurance" component the futures investor provides. This has been discussed in depth by researchers such as Gary Gorton and K. Geert Rouwenhorst, in Facts and Fantasies about Commodity Futures.

Yeah... but I'm righter... ;)

One of the advantages you didn't mention and that paper does not cover is the ease with which one can short, which basically eliminates any issue about commodity prices vs. stock prices. Another is the ease of using anywhere from zero leverage up to nosebleed territory of 50:1 or more, and there are many more.

I could also get into some of the very poorly known and understood issues about comparing long term stock prices against commodities, but I don't want to encourage anyone to jump into futures. But I will mention just one - comparing the Dow or S&P against gold or most other commodities (that bushel of corn is very different in nutritional value and taste from one even as little as 20 years ago) is not even close to an apples to apples comparison, since the components of the Dow have changed hugely over the long term and generally only include the higher performing blue chips.

[Finster]

Re: In the Shadow of 1937

One of the advantages you didn't mention and that paper does not cover is the ease with which one can short, which basically eliminates any issue about commodity prices vs. stock prices. Another is the ease of using anywhere from zero leverage up to nosebleed territory of 50:1 or more, and there are many more.

Oy, but these advantages are also disadvantages ... you yourself have warned of the dangers and risks of things such as shorting and extreme leverage. Best left to experts such as yourself. The type of futures investing Gorton and Rouwenhorst refer to is long-only, fully collateralized, which puts "straight" futures investing on a level playing field with the same with regard to equities.

[bart]

Re: In the Shadow of 1937

Oy, but these advantages are also disadvantages ... you yourself have warned of the dangers and risks of things such as shorting and extreme leverage. Best left to experts such as yourself. The type of futures investing Gorton and Rouwenhorst refer to is long-only, fully collateralized, which puts "straight" futures investing on a level playing field with the same with regard to equities.

Extreme leverage - yes... it is unwise to say the least for most.

But the 'long-only' side of it is an area with which I disagree. It has elements of an "everybody knows" or an "eeeevil" element - shorting, to use an extreme analogy to help make my point, can be quite wise in markets that are downward bound like stocks after Oct 1929 or gold after Jan 1980.

After all, the point was made that commodity prices have gone down on a relative basis on the long term. If stocks tend upwards over time and being long is wisest, why wouldn't being short in markets that tend down also be the wisest? (*tweak* ;)) (and yes, this is another extreme analogy)
If da bear was here from DR, he might say "why does everybody hate shorts?" ;)

[Finster]

Re: In the Shadow of 1937

Extreme leverage - yes... it is unwise to say the least for most.

But the 'long-only' side of it is an area with which I disagree. It has elements of an "everybody knows" or an "eeeevil" element - shorting, to use an extreme analogy to help make my point, can be quite wise in markets that are downward bound like stocks after Oct 1929 or gold after Jan 1980.

After all, the point was made that commodity prices have gone down on a relative basis on the long term. If stocks tend upwards over time and being long is wisest, why wouldn't being short in markets that tend down also be the wisest? (*tweak* ;)) (and yes, this is another extreme analogy)
If da bear was here from DR, he might say "why does everybody hate shorts?" ;)

It sounds like we are talking past each other, talking about futures and commodities as if they were indistinguishable. But the mere fact that futures are the main means for investing and speculating in commodities does not mean they are one and the same.

The facts are undeniable. Over the long haul, stock prices have roundly trounced commodity prices. So DemonD's statement "Stocks historically obliterate commodities" is utterly correct. But this statement alone sidesteps the question of whether returns from investing in commodity futures are comparable to those from investing in stocks. The asnwer to that question is entirely different - in the affirmative as shown by Gorton and Rouwenhorst. The gap is due to the fact that stock prices and commodity prices are not the sole means of returns from investing in stocks and commodity futures, respectively.

The questions of short-versus-long and levered-versus-unlevered have nothing to to with the basic premise. You can invest in stocks or commodity futures either on a short or long, or levered or unlevered basis. This is why Gorton and Rouwenhorst didn't get into those questions; they wanted to examine equities and commodity futures on the same footing. Had they attempted to compare long-only stock investing with short-and-long commodity futures investing, or leveraged stock investing with unleveraged futures investing, their research would not have been published, but round-filed.

The scientific method demands that when comparing two things, all else be kept equal.

Now I would be more than happy to debate the highly dubious wisdom of shorting and leverage, but that would be a separate matter ...

[bart]

Re: In the Shadow of 1937

It sounds like we are talking past each other, talking about futures and commodities as if they were indistinguishable. But the mere fact that futures are the main means for investing and speculating in commodities does not mean they are one and the same.

The facts are undeniable. Over the long haul, stock prices have roundly trounced commodity prices. So DemonD's statement "Stocks historically obliterate commodities" is utterly correct. But this statement alone sidesteps the question of whether returns from investing in commodity futures are comparable to those from investing in stocks. The asnwer to that question is entirely different - in the affirmative as shown by Gorton and Rouwenhorst. The gap is due to the fact that stock prices and commodity prices are not the sole means of returns from investing in stocks and commodity futures, respectively.

The questions of short-versus-long and levered-versus-unlevered have nothing to to with the basic premise. You can invest in stocks or commodity futures either on a short or long, or levered or unlevered basis. This is why Gorton and Rouwenhorst didn't get into those questions; they wanted to examine equities and commodity futures on the same footing. Had they attempted to compare long-only stock investing with short-and-long commodity futures investing, or leveraged stock investing with unleveraged futures investing, their research would not have been published, but round-filed.

The scientific method demands that when comparing two things, all else be kept equal.

Now I would be more than happy to debate the highly dubious wisdom of shorting and leverage, but that would be a separate matter ...

I couldn't disagree more about the facts being undeniable and the same about stocks historically obliterating commodities... and the basic reason is covered in the "their research would not have been published, but round-filed" plus a *creative* approach to the scientific method.

The scientific method, where apples are compared to apples, was precisely my point on comparing stocks to commodities too. Allow me to change the purity of a gold bar the same way that the Dow is rebalanced and its components changed over time, and the picture will change significantly.

But my opinions and views are so far off the beaten path and away from the "conventional wisdom" area that it would be almost worthless to discuss or debate them.

[Finster]

Re: In the Shadow of 1937

I couldn't disagree more about the facts being undeniable and the same about stocks historically obliterating commodities... and the basic reason is covered in the "their research would not have been published, but round-filed" plus a *creative* approach to the scientific method.

The scientific method, where apples are compared to apples, was precisely my point on comparing stocks to commodities too. Allow me to change the purity of a gold bar the same way that the Dow is rebalanced and its components changed over time, and the picture will change significantly.

But my opinions and views are so far off the beaten path and away from the "conventional wisdom" area that it would be almost worthless to discuss or debate them.

Since there is a factual question here, let's take a look at the hard data. The below is a chart comparing broad commodity prices to broad stock prices for the past several decades. The commodity index is made up of the Dow Jones AIG back to its inception, spliced to the CRB prior to that. The stock index is that of the Dow Jones World index, spliced to the MSCI World index prior to that back to its inception, then to the S&P 500. So we have a both a proxy for the price of commodities as a class and for equities as a class. Because of the range of the data, the chart is ... (you guessed it;-) semilog. Thus, the increase in stock prices over the period is 132.8 times versus 4.27 for commodities.

On theoretical grounds, this is not altogether surprising because due to the advancement of technology in mining, agriculture, and industry, commodities ought to become cheaper over time - in real terms - as it takes progressively less labor to produce each unit. The fact that commodity prices actually have risen in nominal terms is a sad testament to the persistence and magnitude of inflation and the erosion of the value of the US dollar.

Worth emphasizing, however, is that these are price-only charts. Dow Jones, for example, publishes separate indices for price and total return for both stocks (Dow Jones Stock Indices) and commodity futures (Dow Jones Commodity Indices). The conclusion reached by Gorton and Rouwenhorst comes about by comparing the total return of investing in commodity futures with that of investing in stocks. Due to phenomena such as the insurance premium and roll yield, the return broadly available from investing in commodity futures - despite the price return disadvantage of commodities per se - has historically been comparable to stocks.

[bart]

Re: In the Shadow of 1937

Since there is a factual question here, let's take a look at the hard data. The below is a chart comparing broad commodity prices to broad stock prices for the past several decades. The commodity index is made up of the Dow Jones AIG back to its inception, spliced to the CRB prior to that. The stock index is that of the Dow Jones World index, spliced to the MSCI World index prior to that back to its inception, then to the S&P 500. So we have a both a proxy for the price of commodities as a class and for equities as a class. Because of the range of the data, the chart is ... (you guessed it;-) semilog. Thus, the increase in stock prices over the period is 132.8 times versus 4.27 for commodities.

On theoretical grounds, this is not altogether surprising because due to the advancement of technology in mining, agriculture, and industry, commodities ought to become cheaper over time - in real terms - as it takes progressively less labor to produce each unit. The fact that commodity prices actually have risen in nominal terms is a sad testament to the persistence and magnitude of inflation and the erosion of the value of the US dollar.

Worth emphasizing, however, is that these are price-only charts. Dow Jones, for example, publishes separate indices for price and total return for both stocks (Dow Jones Stock Indices) and commodity futures (Dow Jones Commodity Indices). The conclusion reached by Gorton and Rouwenhorst comes about by comparing the total return of investing in commodity futures with that of investing in stocks. Due to phenomena such as the insurance premium and roll yield, the return broadly available from investing in commodity futures - despite the price return disadvantage of commodities per se - has historically been comparable to stocks.

Ok... now tell me how many things have been missed or not stated about that chart and stocks and commodities? ;)

You can start with the concept that "Everybody knows that stocks are the best long term investment"... and then for dessert "everybody knows that real estate always goes up"... ;)

[Finster]

Re: In the Shadow of 1937

Ok... now tell me how many things have been missed or not stated about that chart and stocks and commodities? ;)

You can start with the concept that "Everybody knows that stocks are the best long term investment"... and then for dessert "everybody knows that real estate always goes up"... ;)

Let it not be lost that I am not trying to make a case for investing in stocks over commodities, especially now! As they say, past performance is no guarantee of future results. :eek:

Quite the contrary. The weight of the evidence is in favor of commodities - conspicuously including futures on commodities - for probably at least the next few years. My guess is that these past three or so years we've seen but the first wave of two of exceptionally strong commodity performance. Too much money has been printed and interest rates kept too low too long; rates will have to rise and this will be a headwind for the traditional financial assets stocks and bonds. And as you must be aware from the record, while I think most investors should have stock exposure in their portfolios, my position is that stocks of commodity producing companies are first and foremost stocks, and are therefore not a substitute for exposure to commodities through direct holding (as in the case of bullion) and the futures markets.

Are we copasetic on this much?

[WDCRob]

Re: In the Shadow of 1937

Finster, can you explain the comment above in light of your FFF prediction of +17% for the S&P 500?

[Finster]

Re: In the Shadow of 1937

Finster, can you explain the comment above in light of your FFF prediction of +17% for the S&P 500?

Sounds like someone is paying attention! ;)

The discrepancy stems partly from time frame and partly from relativity. My forecast for the S&P for 2007 is a 20.45% gain in dollars. The comments above are more oriented towards the longer term, i.e. "probably at least the next few years". Moreover, the S&P 500 prediction you cite relates stocks and dollars, whereas the above comments relate stocks and commodities.

[bart]

Re: In the Shadow of 1937

Let it not be lost that I am not trying to make a case for investing in stocks over commodities, especially now! As they say, past performance is no guarantee of future results. :eek:

Quite the contrary. The weight of the evidence is in favor of commodities - conspicuously including futures on commodities - for probably at least the next few years. My guess is that these past three or so years we've seen but the first wave of two of exceptionally strong commodity performance. Too much money has been printed and interest rates kept too low too long; rates will have to rise and this will be a headwind for the traditional financial assets stocks and bonds. And as you must be aware from the record, while I think most investors should have stock exposure in their portfolios, my position is that stocks of commodity producing companies are first and foremost stocks, and are therefore not a substitute for exposure to commodities through direct holding (as in the case of bullion) and the futures markets.

Are we copasetic on this much?

I very much agree on the past performance position and generally also do about the commodity and hard asset position, as shown by the roughly 15-20 year cycle in the Dow/gold or Dow/(most commodities).

But my point isn't about that. I maintain that the apparent out performance of stocks over commodities over the long term is, at the very least, highly over stated.

It's also not a valid apples to apples comparison, and could be compared to a statement that a new dining room table at $500 can be validly compared to one's grandparents new dining room table bought new for $50 in the '20s.

The official CPI-U has roughly 10x'ed since the '20s and it seems to be a valid comparison. That table is 10x more expensive than theirs and the CPI has 10x'ed and they both do the same function well... apparently. But they're nowhere near the same table. One is solid wood and the other is plastic, veneer and particle board. There are obviously many more differences, and I could go off into a diatribe about "reverse hedonics" but that would just be off the subject and point.

Overall though, my view on stocks is not exactly a popular or welcome one and I generally avoid discussing the area since it very much flies in the face of conventional wisdom.
I already do that enough on my web site... ;)