Saturday, May 14, 2011

A diversified portfolio enables you to take the long view

As a budding investor I watched the stock market day by day. I got concerned when a stock did not keep up with the market because it affected my portfolio significantly. Today, I couldn't care less. Only when an investment hasn't panned out for several years do I start to wonder if I should get rid of it, or hold on, or to buy even more.

Last month oil prices were sky rocketing and oil stocks peaked. This month we have a large correction. The earlier media screams about buying the hottest oil stock in town have been replaced by cries ranging from the end of the 'oil bubble' to changing your portfolio significantly away from commodities. As if one could do that when invested in only the Canadian stock market! Look if commodities prices crash, so will real estate and so will manufacturing and so will Canadian banks. In Canada, all is intertwined. Never forget that!

When looking at the masters most take on the longer view, whether it is W.B. (the oracle of Omaha) or John Templeton or Jim Rogers who was recently quoted in the Globe and Mail.

On the 'collapse of silver', Rogers states: "I hardly see how silver could be a bubble when, even at its [recent] top, it's still below its all all-time high. That is not much of a bubble. A bubble is when things are screaming up every day and they go to new highs, two to three times their old highs. We'll have a bubble, we'll have a bubble in commodities, we're not there yet."

Question: So silver fell 27 percent last week, was it enough for you to buy more?

Rogers: "Well, I'm too lazy, I'm doing other things right now, but I hope at some time in the next month or two if it goes down or stays down then I will get the energy to go around and buy some more silver, yes. Or maybe it will go to $25, I don't know".

Question: But didn't you sell anything?

Rogers: "No, no, no I have not sold any commodities. I protect myself by being short… in other things. I am nearly always short in something. I'm nearly always long something, fortunately my shorts went down too last week."

Question: So what are you short versus long?

Rogers: "Well, I'm short emerging markets and I'm short American technology stocks cause those are two areas of the world stock markets that have been very over-exploited in the past two to three years. They're not great bubbles, they're not great shorts, but they're better shorts than nothing."

[Godfried's comment: does that mean that he is overall bullish?]

Question: Then what are you long? Commodities then?

Rogers: "I'm long commodities, mainly its commodities and currencies.

[Godfried's comment: Here comes the crux regarding the long view of a seasoned investor]

Question:" Now you've been saying that there is no oil and that's why oil prices are going up. What did you specifically mean by that?"

Rogers: "Well, there have been no new elephant discoveries in over 40 years. All the great oil fields in the world are in decline now and unless we find a lot of oil quickly then we're not going to have any oil at any price. The international Energy Agency is going around saying "look, the world is running out of known reserves at 6 per cent per year."

Well say its 4 per cent per year, say they're wrong. I mean in 25 years, Ms. Steel, we won't have any oil at any price unless someone does something very quickly that's all I mean, there's no oil, there's no new oil."

Question: It just seems like if that's the case then natural gas price should be through the roof in preparation of a lack of oil?

Rogers: "Well, there is a short term glut of natural gas, but you're exactly right, people are going to have to use other forms of energy and if I were looking at energy markets right now I would start by looking at natural gas because its way down and oil is way up."

Question: So how high will oil go on this supply issue?

Rogers: "Oh, if I told you how high the price of oil would go over the next decade, you'd stop talking to me, you wouldn't believe me. 'He's finally lost it, he's gone over the deep end.'

Do the arithmetic. If reserves are going to continue to climb [Godfried: should be 'decline'] at 4 per cent-5 per cent-6 per cent a year, in 10 years there is going to be very little oil left. Now we would have brought in alternate sources such as natural gas and other things but we are still going to be in a bad bind. Prices are going to be very high.

Eventually prices will go so high that people will probably start finding new oil ... if oil goes to $200, they'll drill on the White House lawn, $300 drill at Buckingham Palace. Hopefully, someday, we'll find more oil, or more sources of energy and people will cut back at the same time."

So natural gas would be the one you'd focus on?

Rogers: "I would start by looking at natural gas or maybe uranium. Uranium has been pounded down recently for obvious reasons. It will probably have to sit around on the bottom for a while but that's another place that's very depressed. And we are going to have to have nuclear power whether we like it or not. "

But say wind and solar don't make it on your list?

Rogers: "No, of course it does ... but wind and solar are not economically competitive at these prices. Now if prices go higher and higher of course, they'll be very competitive and, of course, governments love wind and solar, so they will subsidize. If you can find competent people in that business, you'll make a fortune. "

I know I've been harping on gold, silver, and oil but what is your favourite commodity? The one you think that has the most upside long term?

Rogers:" If I were looking for new commodities now I would start by looking at the things that are depressed. Natural gas, you picked an obvious place to start, I would look at things like rice, rice is very depressed ... silver's cheaper than gold on a historic basis.

I would start looking at those places. I don't like to start with the things that are making new highs. By the way, there are plenty of great investors who do invest that way, they are momentum players. They jump in and get on a moving train. I'm scared to death to get on a moving train and if I do I always get hurt. "

Godfried's final comments: If you have enough investment funds you can afford to buy low now, e.g. natural gas, and wait for several years for this investment to come to fruition. It does not take a genius to figure out that gas is selling at prices below which it can be explored and produced. So it is just a matter of time for prices to double or even triple. Can you wait for 5 years for the price to double? As Jim Rogers says: "Do the math" and use the rule of 72. Divide 72 by the number of years it takes for your investment to double and the result is your annual compound rate of return. So 72 divided by 5 is 14.4% compound ROI per year.

You can look at real estate the same way. Prices in Calgary rental condos are depressed but on average over the last 40 years or so they appreciated at a rate of 4 to 6%. Using leverage that would translate in a return of nearly 20% as shown in earlier posts. So can you outwait an undervalued real estate market?

With a small portfolio waiting five years while it does not grow or even declines may seem interminable torture. But over the long term holding on will bear its fruits. If you have a diversified portfolio, other investments may take up the slack and it may be easier to be patient.

Also, larger investors have learned that this approach works. That is why the Warren Buffetts and Jim Rogers of this world have the fortitude to stick with their bets unless there is a truly fundamental change such as the discovery of a cheaper alternative energy than oil. For now that is a risk far out at the investment horizon; even for Jim Roger's investment horizon. Jim is in his seventies and Warren Buffett is in his 80s, so how long an investment horizon can you have when you're 25? Especially if you're thinking family net worth, this may include future generations!




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