Sometimes being fundamentally correct
can be monetarily wrong.
This was the title of an article that
I wrote in July of 2005. My argument was that even though the fundamentals
might be correct in the long-term, investors can lose tons of money if they
stubbornly hold on to their views. I thought it would be interesting and
educational to repost some of the comments that I made in the article,
especially in light of the current market environment. Remember, this is July
of 2005:
“The most glaring example of
this has occurred most recently with the US real estate market. First, I
believe that real estate prices should not rise in a recessionary
environment. Furthermore, with the burst of the dotcom/tech bubble, one would
assume that investors would not have the excess equity to upgrade to a bigger
home or buy a second home. Nonetheless, the obvious boom in real estate has
resulted in tremendous capital appreciation for many real estate investors.
This trend has lasted for several years, soaring in the face of fundamental
reasoning.
Of course, some would argue that home
prices have risen because of artificially low interest rates and interest
only loans. I do not disagree with this analysis. In fact, I believe that the
real estate market is indeed overvalued. However, I also believe that trends
often follow the demand of the investor. In this case, investors decided to
take advantage of the low interest rates and "special" mortgage
programs. This demand has ultimately led to an increase in home sales, and
subsequently a rise in home values.
This idea that trends often ignore
fundamental reasoning can be found throughout the markets. The US dollar
index is another example of this. I consider myself bearish when it comes to
the US dollar. I cannot easily disregard our twin deficits and a slew of
other fundamental reasons on why the dollar is overvalued. However, since
about June 2003, the dollar has experienced three relatively substantial
counter rallies. In fact, we are in the midst of the most prominent of these
rallies. Take a look at the below dollar index chart.” (Emanuel
Balarie, 2005)
Several years later, it is clear that
my fundamental analysis was correct. The real-estate market burst and the US
dollar (trading at the time at 90) eventually broke down to new lows.
However, it is important to note that investors still had a couple more years
to profit from the growing real-estate market even though the fundamentals
did not make sense.
What about today?
My office is located at the Chicago
Board of Trade and I often get the opportunity to interact with several
different types of traders. While these traders have one common goal- to make
money- they differ in terms of the markets they trade, their trading style,
and their overall outlook on the markets and the economy.
Having talked to these traders, it is
also clear that they share my sentiment that having a solely fundamental
focus on the markets is not really working today. Indeed, many
“value” or “contrarian” traders who look to buy
undervalued (or sell overvalued) positions have had a tough time reacting to
the recent characteristics of this commodity markets. Momentum and
trend-following traders, however, have been able to profit from these prolonged
market trends.
By the way, you can log on and access
some of the performance for these Commodity Trading Advisors.
This makes perfect sense. Take oil,
for example. Several months ago, when oil was at $110/ounce, I wrote an
article titled “Oil Bull Turns Bearish”.Oil prices, of course,
continued their march towards $150/barrel. In the article, I stated the
following:
“In fact, I want to let you know
that I am as big of long-term commodity bull as they come. I understand the
fundamentals that are driving this commodity bull market...I have even
written a Commodities book about it! However, I also understand the
speculative froth that often enters the markets...and the trend following
approaches that hedge funds and other traders implement. The leverage aspect
of the futures markets also allows for a lot of money to come in( and go out)
in a quick period of time. The end result, of course, is that while the oil
bull market will continue to climb higher for the next 7-10 years, it will
also experience extreme volatility as prices will often get ahead of
themselves.
In my opinion, we are now in the oil
pullback mode. The move to $110/barrel was largely based on speculation and
hedge fund interests. Fundamentals did not warrant such a rapid move up.
Currently, energy supplies are showing a buildup and a slowdown in the US economy (the largest oil consumer) will have an impact on oil demand.”
Was I wrong in my fundamental
analysis? I don’t think so. Prices have eventually sold off, and I
think we will see a further sell-off in the oil market. However, it is pretty
clear, that markets contradicted the fundamentals and moved substantially
higher. The traders and investors who were able to make money in this market
environment were those that simply continued following the trend.
Last week, I also mentioned that the
fundamentals dictate higher gold prices moving in to the gold buying season
and that the rally in the US dollar was short-lived. My reasons were based on
the fundamental factors that I outlined. Was I correct? Not in the
short-term. The US dollar has continued to rally (in the midst of dismal
economic data) and gold prices have sold off even more. Does this mean that
this recent gold-sell off should signal an end to the gold bull market? No.
It just simply means that the trend is currently contradicting fundamentals.
What’s an Investor To Do?
But what’s an investor to do?
While this logic makes perfect sense, it doesn’t take away from the
fact that many investor portfolios have declined significantly due to the
recent commodity sell-off. Should you hold steadfast to your long-term
commodity bull market view point? Or should you sell all your commodity
investments all-together? I think the answer lies somewhere in between.
First, it is important to realize that
panicking and selling all of your commodity investments due to the current
correction is not necessarily the answers. The fundamentals warrant higher
commodity highs, and these type of drastic sell-offs can often provide great
buying opportunities. You need only to look at a chart of the CRB index over
the last 7 years to see why this is the case.
But beyond holding on to your
commodity investments, it is important to note that simply having a
“buy and hold” and “fundamentally-focused” investment
philosophy is not optimal for an investment portfolio. You need only to look
at the recent sell-off and volatility in the markets to understand why this
is the case.
So while the trends have contradicted
fundamentals over the past year, it is important to now take time to
re-evaluate your portfolio. We are living in the midst of changing times and
changing markets. While having some “buy and hold” assets in your
portfolio makes sense, you should also con also consider diversifying your
portfolio among other type of investments, trading managers, and trading
strategies. To find out more, I encourage you to read my article from a
couple months ago “
Managing Wealth in a Bear Market”.
If you would like to find out more
about the managed futures products and strategies that can help diversify
your "fundamentally focused" portfolio, please visit: (
http://www.balariecapital.com/ )
You can also sign up for a CNC weekly commodity
newsletter.
Emanuel
Balarie
Jabez
Capital Management
www.commoditynewscenter.com
Emanuel Balarie is President and CEO
of Jabez Capital Management. In addition, he is also editor of www.commoditynewscenter.com and the author of Commodities For Every Portfolio: How To
Profit From The Long-Term Commodity Boom. Mr. Balarie's
industry experience ranges from commodity stocks to futures to alternative
investments. He is a highly regarded advisor to clients and institutions on
the commodity markets, and has had his research published all over the world.
In addition to being a regular guest on CNBC, Balarie is frequently quoted in
financial publications such as, The Wall Street Journal, Reuters, Marketwatch
from Dow Jones, and Barrons. Mr. Balarie is a graduate of UC Berkeley.
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