jaudio shorts

SLO players, including myself, have been loaded with great performing commodity stocks and ETFs that have buoyed us in the turbulent markets. Just take a minute to gaze at the portfolios of some of the top 50, and you'll see many with agriculture holdings (MON, MOS, POT, ADM), many with miners (PCU, BHP, AAUK, FCX, NEM, GC), and of course, coal and steel. Commodities have been king, and I am slowly jumping off of the bandwagon and shifting money the other way.

Today I cut my positions in MON, POT, SYT, MOO, and BG. The first three have done well in the short term, and BG popped today. My decision is based more upon my long view of macro-economics than the technicals of each. Ahknaten made a great case of POT being overvalued in his last blog entitled, "POT may be legal in B.C. but . . ." and Vad Yazvinski speaks more about the agriculture plays in his April 3rd entry, so I won't retrace their steps. Commodities, just like everything else in investing, have their ups and downs. The past 2 years have been amazing for agriculture, and miners, but the party won't last forever. To believe that both will continue the march upward into perpetuity, powering through a US recession is going against tough odds. What are some of the reasons cited for the continued climb?

1. Demand from China.
Not a day goes by without hearing about the China boom that is driving up the cost of everything. As long as China continues to grow, some believe commodities will remain resilient even in a US slowdown.

2. Everyone eats, therefore, agriculture will continue booming. Furthermore, as more of the world develops and diets improve, better food will be demanded by more people pushing agriculture even higher.

3. More people are demanding petroleum products, not only in the USA, but China and the emerging markets. Coupled with limited, finite supplies, oil will move ever upward along with any companies connected to the drilling and refining process. This strengthens the case for using other forms of energy, like coal, and higher demand for coal will lead to higher stock prices for those companies.

There are more factors thrown into the mix, of course, but the three above seem to be the ones that are talked about from time to time. I am not about to put forth arguments against the continued climb of commodities, but only because others have done it much better than I ever could. A great article to read is by Eben Esterhuizen on seekingalpha.com regarding this:

http://seekingalpha.com/article/70034-why-commodities-are-likely-to-struggle-in-2008

I do agree that speculators can push up commodities in the short term, but not as a long term trend. I am long on gold with GLD, and will remain so at least for the next couple months because I believe the weakening dollar and the threat of inflation make it a safe haven. Despite my seemingly contradictory position on gold and the basic materials sector, I say all of the above, to make one point, and that is this: If you believe as I do, that commodities have made their run and are on the cusp of falling back down to earth, then you must position yourself to make a profit from it. You can do this in several ways, but my way is staking a position in the Ultra Short Basic materials ETF, SMN.

As I stated before, I have cut several of my positions in the agriculture stocks, but have not eliminated them completely. I do this only as a way to spread my risk. There could still be a lot of money left to make in agriculture, and if so, I will capture part of the gains as I slowly sell out of them. Conversely, if the agriculture stocks take a dive tomorrow, I have booked some profits today with no worries. During this time of selling the agriculture positions, I am also increasing my stake in SMN. For a short period of time, I will cross into a zone where my money is perfectly balanced between the two, almost canceling any movement up or down. Gradually, though, my stake in SMN will increase reflecting my own macro-economic view that commodities will go down as the US enters recession. As the US goes into recession, SMN will go up as the commodities come down.

SMN is designed to inversely double the Dow Jones US Basic Materials Index. This index contains a lot of our favorites in the SLO, with major steel, coal, agriculture, chemical, and mining companies as components. (For a component list, go to www.djindexes.com) It's no wonder that basic materials ETFs have been soaring since the majority of the companies in the index have prospered greatly in the past few years. This is the reason that SMN is so dangerous. If commodities continue up, I will be losing doubly. Before today, my original stake in SMN was down over 17% . . . that's a nice paper loss, embarrassing to the most stoic of players. I bought it at the wrong time, and only bought it one time, without averaging in. This time I am playing it safe. I took a 14k stake today, and I will be taking at least 2 more similar stakes in the next 2 months. The only reason I may hold off on taking a bigger position will be if commodities crash rather than taking a slow ride down. Again, it may hurt me in the short term, or even for the contest, but I believe my strategy is sound. SMN is trading just a tad above its 52 week low, and at $34 a share, its way off of its January 22nd close which was around $53. Any chinks in the commodities armor can become bigger problems in another mini-panic sell off. If that happens, those that positioned themselves on the short side will clean up.

Where do you stand?

I've made my decision. Anyone want to raise me one?

---Jonathan

Comments: View Comments |  Monday April 14, 2008