Gaining from Commodities

September 2008 2008

Gaining from Commodities Key reasons for investing in commodities are: diversification, rising demand, By William Parmenter, editor and to take part in the global shift in living conditions and consumption patterns. Other The Los Angeles Chapter of AAII held a reasons include: preservation of capital, seminar on alternate investments, featuring three reduction of volatility, and out-performance. different speakers, on Aug. 23 at the Skirball The value of diversification is that by Center. Roger Schaar, head of the chapter’s broadening your holdings across different asset alternative investing group, organized the event. classes one lowers overall return volatility by The speakers and their topics were: Alex spreading risk. Numerous studies have shown Merk on Global Investing (discussing how to that commodities possess low to negative diversify in the global economy as the dollar correlations with stocks and bonds over the long weakens); Richard Jackson Sr. on Profiting from term, and offer protection from inflation. Foreign Currency Trading (presenting on global foreign exchange solutions); and Gavin Maguire Commodity Correlations and Time Periods on Adding the Red Hot Commodity Markets to Your Portfolio (discussing how investors can gain Stocks Bonds Inflation from commodities). Gavin Maguire, director of research at the Monthly .05 -.14 .01 Iowa Grain Company, gave reasons for investing Quarterly -.06 -.27 .14 in commodities, and showed trends illustrating increased future demand for commodities. His One-Year -.10 -.30 .29 presentation was accompanied by a show of 38 Five-Year -.42 -.25 .45 slides. The following material includes The chart shows the correlation of information from an outline Maguire wrote on his commodity returns with stocks, bonds and talk and data from his slide show, which is posted inflation from 1959 to 2004. The data shows for your reference on the chapter website at: that over the longer term, commodity returns are www.aaiilosangeles.org. negatively correlated with those of stocks and It is an exciting time to be investing in bonds and positively correlated with inflation. commodities—a field that can be very profitable Rising demand for commodities can be when commodity prices are rising, according to Maguire. Table of Contents Investors need to take a proactive Gavin Maguire……Gaining from Commodities……p.1 approach and seek out commodities with strong Joe Kinahan…Profiting from Options in Your IRA…p.3 growth, and inflation-fighting potential. Mike Turner… Right Time to Buy and Sell ETFs…...p.3 Don Gimpel...... Education Nuggets………………..p.5 William Parmenter…What Is Up With the Markets…p.6 1 illustrated by thinking of your rising use of yields are in North and South America. commodities: in your breakfast, your car, your Soybean crops are expanding in Brazil and computer, and when you go to Starbucks for Argentina. coffee. Every day consumers use a wide array of Sugar is used in chocolates, sweets and raw materials and commodities, for example soda pop. It is a major fuel source in Brazil and butter, coffee beans, corn and aluminum in cans. elsewhere. Sugarcane transformed into biofuel These and other products like them are available yields more energy than corn. in limited quantities, but demand, with a rising Opening a futures and options trading global population may grow greatly. account at a brokerage allows one to personally Perhaps the most important reason to get invest in commodities growth. involved in commodities is that they allow the The brokerages, EHedger LLC and investor to take part in global shifts in living Prime Investment Service, both founded by conditions and consumption patterns. Iowa Grain Company, offer industry-leading The middle class is expected to double in personal service and risk-management size by the year 2030. Especially fast growing strategies. have been the BRICs and the Middle East. Their To fill out an application to start an populations are: China, 1.3 billion; India, 1.1 account, or to obtain more information, call 1- billion; Brazil, 192 million, Russia, 142 million, 866-433-4371, or 1-312-786-4201, or visit the and the Middle East, 200 million. The BRICs following websites: www.ehedger.com, have almost half of the population of the planet. www.primeinvestllc.com, or [email protected]. There will be greater demand for roads, electricity, buildings, restaurants and food. Population growth, rising consumerism, infrastructure build out, rising education levels Los Angeles County Meeting and increased travel and communication will all Schedule fuel rising demand for commodities. Westside Computer Group – Don Gimpel, 310/276-9875 India is an example of great growth [email protected] Sat. Dec. 6, at 10:30 a.m., Veterans of potential. An estimated 400 million people still Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City, Topic TBA. do not have electricity. Rural areas lag the big Pasadena Group – Pasadena Library 285 E. Walnut Street, cities in infrastructure. In the next ten years the Topic and date TBA

Indian government is expected to provide Mutual Fund Group – Gunter Hagen 310/457-7404, electricity to everyone, thereby initiating large [email protected]. 10:30 a.m. Sat, date and topic TBA, in the community room of the Fairview Branch of the Santa infrastructure improvements. Monica Public Library, 2101 Ocean Park Blvd., Santa As the world population increases so does Monica. The meeting is free to the public the demand for grains. Demand and production Stock Selection Group—Norm Langhout, 310/391-6430, for wheat, corn, rice and soybeans, the chief [email protected]. Fourth Wednesday of the month at 7 p.m. Fairview Branch of Santa Monica Library, 2101 grains, increased in 1980 from 1.2 billion tons to 2 Ocean Park Blvd., Santa Monica. Topic TBA billion tons in 2008. San Fernando Valley Group – Mid Valley Library Community Commodities with long-term potential Room, 16244 Nordhoff St. North Hills, Topic, TBA include corn, soybeans and sugar. Corn is the IBD Meet-Up/AAII CANSLIM Group – Santa Monica Library, most efficient protein known, a diet staple in Fairview Branch, 2101 Ocean Park Blvd., Santa Monica Mexico and Central America. Corn is used to Los Angeles Chapter Mtg.— Skirball Center at 9 a.m.,Oct. make syrup, sweeteners and biofuel. 18, The Case for Market Timing by Mark Leibotvit; and Five Soybeans are an Asian food staple, and a Steps to Launching Your Own Entrepreneurial Forex and major animal food. It is used for salad dressing, Futures Trading Career, by Michael Radkay preservatives, cooking oil and fuel. The best Profiting from Options in Your IRA 2 In option trading Kinahan likes trading By William Parmenter, editor in Spiders (S&P 500) because he likes being the smallest fish in the biggest pond. He likes Joe Kinahan talked about using trading in high volume markets. options in your IRA account to enhance returns at Calls usually sell higher than puts, the Sept 20 Los Angeles Chapter AAII meeting at because calls carry interest rates. Puts the Skirball Center. occasionally sell higher than calls because puts Kinahan is the chief derivatives strategist carry dividends. at Thinkorswim. He addressed the topics of how Strategy Three: Selling index call to effectively trade options; how to enhance IRA spreads to enhance mutual fund returns. You returns using options; and how to better allocate should pick an index product that you believe capital. will have the closest correlation to your Investors can enhance their portfolio portfolio and then sell a very tight (narrow return by using the ThinkorSwim guide to using strike) vertical credit spread in the near month options. Thinkorswim, a nine years old firm, has (23 days to expiration) and approximately two developed its own trading software, which was percent above the current underlying price. rated number one by Barrons. Kinahan ran through an example to Premium selling techniques will add .25 explain strategy three, pointing out it is a good percent to .45 percent to your portfolio on a way to enhance returns from index funds. monthly basis. Over the last 50 years, no-load index Investors can keep two accounts, a trading funds have outperformed 96 percent of managed account and a retirement account. An attraction is mutual funds. that self-management provides for significant cost At Thinkorswim $3,500 is the minimum savings. amount to open an account. One hundred A balanced model portfolio would be 50 thousand dollars in play money is given to percent stocks, 30 percent cash and 20 percent practice with, so novices can build their trading other. Whatever your allocation Kinahan stresses skills. By Oct. 15 the firm will have access to that you should keep it balanced all the time, and Canadian stocks. not just rebalance it once per year. The investor Thinkorswim has a trading desk with 40 should be consistent with his portfolio allocation people, of whom 32 are former market makers. over time, as market timing tends to lead to The goal of market makers is to hit singles all emotional, negative decisions. day long, for example making five cents over Kinahan reviewed various strategies, and 500 times a day. Doing so, one can make a very then worked through examples to explain them. handsome living. Strategy One: Selling cash-secured puts to Kinahan had more strategies, but did not establish long stock positions. Kinahan worked have time to share them. His very well received through an example of buying Citigroup that talk sparked considerable interest. His email allowed you to be wrong and still make money. address is [email protected]. Strategy Two: Selling calls against long stock to enhance your returns: The Right Time to Buy and Sell ETFs Using a blanket generalization, selling covered calls will add approximately one third of By William Parmenter, editor one percentage point per month your total return. For consistent results find the nearest expiration Mike Turner presented a talk on month with at least 23 days to go and sell the knowing the right time to buy and sell exchange nearest strike OTM call. Doing this in your IRA traded funds (ETFs) at the Sept. 20 meeting of account brings no tax consequences. the Los Angeles chapter of AAII at the Skirball Center. 3 Turner, a former engineer, addressed the sales lines cross, it is an inflection point, and points: when to sell, how to manage a portfolio market direction changes. without emotional interference, and setting up an Turner said if you don’t know where the intelligent stop-loss methodology. market is going, he did not know how you could Turner worked twenty years with a make money. He likes to be in the middle of the software company. Then he looked for a good market trend, moving in the middle, as out of software tool for making money. Not finding one, the edges you can get eaten. he made his own. (One would like to know how Turner’s He gave background information on the system would fare in a highly volatile market difference between stocks and ETFs. One share like that of the week of Sept. 20 when the Dow of an ETF can represent ownership in a single went down 504 points on Monday; up 142 commodity (eg. gold), or an index (eg. the S&P points on Tuesday; down 449 points on 500). Shares in an ETF trade like a stock, for Wednesday; up 410 points on Thursday; and up example, you can put in limit and other kinds of 369 points on Friday. Which way did Turner’s orders. software system, which updates the data weekly, Stock prices go up and down driven by think the market was going that week? supply and demand. ETF prices go up and down Although the Dow was down only 28 points on based on the price of its holdings, and on supply the week, would his investors have been and demand. devastated by the historic volatility?) Most ETFs are directly correlated to the To pick the right ETF when focusing on ETFs holdings. Some ETFs are inversely regions, Turner watches money flows into correlated to the ETFs holdings (ones shorting the countries. In flows produce high country ETF market). (You can buy an inverse ETF in your prices. Japan is in a strong buy mode, as has IRA account; however, short sales were been gold since October, 2007. prohibited for in 799 financial stocks on Sept. 19, The main reason to buy an ETF is to sell until Oct. 9, which would affect financial index it so as to make money. The only way to make ETFs.) money is to sell it at the right time. Investors In investing, it is important to know what want to buy and hold as long as the ETF is kind of market you are in. Since Jan., 2000, the making money, then you need to sell. Avoid Dow 30 has been in trading in a range around buy and hope, and buy and hope to get even. 11,000. From 11,500 in Jan. 2000, the Dow Technical trading systems have one dropped to 8,000, then rose to l4,000, (a gain of characteristic in common: they need to be able 75 percent), and dropped by the second week in to distinguish between normal volatility and a October to 8,600. change in direction. Turner always puts in a (Turner was using the Dow as a proxy for stop loss, based on last week’s low, minus the the market since it correlates 94 percent with the expected move. S&P 500, which in turn, accounts for about 70 Regarding asset allocation, Turner cent of the total U.S. market.) favors equal allocation. For example, if the Turner’s observation about the Dow’s investor had a ten ETF portfolio, he would current activity was that four times in history the allocate ten percent to each ETF. Dow traded in an extended trading range; each Selling is the hardest part of investing; time it was followed by a bull market. Turner teaches people how to do it. (Reinterpreting the data in different words, secular He shared some buy rated ETFs with the bear markets are followed by secular bull audience. They included the following, by markets.) ticker symbol and a name tag: XRT, S&P retail Demonstrating his proprietary software, Spider; IAT, I Shares Dow Jones regional Turner pointed out that when long buys and short banks; IBB, I Shares Dow Jones, U.S. Home 4 Construction, positive since three weeks ago; If you would like to check the accuracy IYK, I Shares Dow Jones, U.S. Consumer Goods, of stock market forecasters, go to the website positive since two weeks ago; cxoadvisory.com and click on the gurus link. KBE, KBE Bank ETF, small regional Under the title “Guru Stock Market banks, positive since two weeks ago; KRE, KBW Forecasting Grades,” the page rates 50 regional banking, positive since two weeks ago; forecasters and gives them an accuracy score. PFI, Power Shares Dynamic Financials, positive The top five were: since two weeks ago; and XHB, another home David Nasser at marketwatch.com,with 68%. builder. James Oberweis at Zacks.com, with 65% Turner does not buy falling knives; he Ken Fisher at Forbes.com, with 63% waits for the market to move in an up direction, Jack Schannep at Zachs.com with 61%, and then he buys. Buy signals to look for: the market Jason Kelly at jasonkelly.com, with 60% turns up, insider buying, institutions buying, All other forecasters were below 60 volume rising and industry in a bull market. To percent. The average forecaster’s accuracy was determine whether the market is bullish or 48% (worse probability than a coin flip). bearish, he compares the number of stocks The popular Jim Cramer at New York moving in each direction. Metro had 46% accuracy, while Jim Jubak at More of Turner’s stocks make money than MSNMoney.com had 42%. The worst was do not. He looks at the market on a weekly basis. Steve Saville at Safe Haven with 15% accuracy. He thinks the market will go up in the next three (One wonders, what kind of a safe haven was to four months. that?) His Market Trend Portfolio is up 13 Gimpel reminded the audience of the percent since Jan. 2002, and his Turner Trends around 100 spreadsheets that he is sharing on Covered Call Portfolio is up 16 percent since the chapter website at www.aaiilosangeles.org. June, 2006. On the home page look for the link to Don’s For more information call (888) 628-5556, page; there you will find a series of or go to www.turnertrends.com. For those spreadsheets. interested in reading his book, it is titled 10: The Look for the Excel spreadsheet that Essential Rules for Beating the Market, and is would have told you to get out of the market a available on Amazon.com week ago (around Sept. 13). Each month about a week before the Education Nuggets Skirball meeting Gimpel puts more Excel spreadsheets on the chapter website, covering a By William Parmenter, editor variety of financial topics. Another website Gimpel recommends is Don Gimpel gave a five minute talk on www.gummy-stuff.org, run by a retired investor education at the Sept. 20 Los Angeles professor of statistics, which has a great wealth AAII chapter meeting at Skirball Center. and variety of financial information. Gimpel started by asking the audience how many of them used an advisor or broker. About half the audience responded that they did. The Los Angeles Chapter website is: Then he asked how many were told by www.aaiilosangeles.org their broker that we were in very perilous Getting Started with Options financial times. Only four people raised their hands. That knowledge—that the investor is on By William Parmenter, editor his own—was an educational nugget in itself.

5 A newly formed options investing group Yahoo finance. It showed options on SPDRs, held its first meeting, with 25 in attendance, under RQQIVX and RQQIWX. He traced out the founding direction of Robert M. Wall at 10:30 examples of bids (price someone will pay) and a.m.Sept.27 at the Veteran’s of Foreign Wars asks (price someone will sell for). Building in Culver City. Other topics covered by Wall included: Wall retired two years ago. Since then he type of options, parameters of equity options, doubled his account trading options. four charts that showed various situations of risk Some of the meeting was spent on and selling. He also covered call pricing, the organizational matters with Wall explaining the covered call, and put up a chart that showed need for transparency, oversight, accountability how a call worked in up and down markets and distributed leadership. Depending on investor between 1985 and 2008. interest, the group will keep meeting. Using options investors can get a few One needs some expertise to trade options percentage points of advantage in an up market as 80 percent of the people who trade them lose (to increase gain), and a few percentage points money, according to Wall. The firm selling the advantage in a down market (to reduce losses). options is the one making money, in most cases. At this meeting Wall covered the basic For basic information on options one can vocabulary of options. At the next meeting, go to wwws.investopedia.com, or to Wikipedia, or time and date to be announced, he will talk to www.CBOT.com (the Chicago Board of about a slightly more complicated way of doing Trade). One could also go to thinkorswim.com, a covered call. which has tutorials. Two books on options are: Lawrence G. McMillan, Options as a Strategic Investment, fourth edition., published by the New What is Up with the Market? York Institute of Finance, and, Sheldon Natenberg, Option Volatility and Pricing. By William Parmenter, editor Wall put up a four-cell chart that defined the basics of buying or selling (writing) a call or a People are scared as they watch the put. The information in the cells was as follows: stock market’s extreme volatility and see the For buying a call: The buyer of the option indexes dropping off a cliff. has the right, but not the obligation, to buy an Panic selling and the collapse of agreed quantity (…) at a certain time (the financial titans has scared everybody all the way expiration date) for a certain price (the strike up to President George W. Bush and all the way price). down to the man on the street. For selling (aka writing) a call: The seller The volatility represents extreme (or writer) is obligated to sell the commodity at uncertainty in the marketplace. the strike price (…) should the buyer so decide. The steep decline in the indexes The buyer pays a fee, called a premium for this represents the market re-pricing on the negative right. side the severity and duration of the recession. For buying a put: The put allows the buyer We know it is bad and going to get the right but not the obligation to sell (…) to the worse. It’s a recession when your neighbor writer (seller) of the option at a certain time for a losses his job. It’s a depression when you lose certain price (the strike price). your job. It is a disaster when your assets (and For selling a put: The writer (seller) has you thought you were going to ride it out) the obligation to purchase the underlying asset at decline to zero. that strike price, if the buyer exercises the option. On Oct. 7, the Dow plunged 508 points Wall projected a screen from his computer to 9,447. Only 19 more days like that and the that illustrated buying and selling options from Dow will be at zero. At zero, timers won’t have 6 to be worried about capitulation false alarms, July 1990 to Oct. 1990, minus 20 % because the game will be over. (The average bear market decline was 34 %.) If you have already lost your fortune, What can you do in the current panic? don’t despair. Apply for a position as CEO of an Do what millions have already done—fly to S & P 500 company. Last year those CEOs made safety, secure your assets against losses. an average of $10.5 million, or 344 times the pay If you are a retiree, safe money places of a typical worker, according to a study by the include short-term U.S. Treasury bills, CDs Institute for Policy Studies and United for a Fair within FDIC limits and fixed annuities. To get Economy. your savings in a safe place, check out the Rep. Henry Waxman’s House committee website www.safemoneyplaces.com. has started investigating big payouts and golden You can determine that your deposits are parachutes to CEOs of failed firms. Reformers within the FDIC insurance limits by using the will advocate that CEOs of firms that went bust FDIC’s Electronic Deposit Insurance Estimator shouldn’t get big payouts and should get dropped and other online resources at over the mid-Atlantic in a lead parachute. www.fdic.gov/deposit/deposits, or by calling the Some 900,000 homes have gone into FDIC at 1-877-275-3342 foreclosure, with an estimated two million more to go. That indicates a long and bumpy road ahead. Note to Pro Forma Contributors To put the current bear market in perspective here is a list of the worst declines of Please have your copy emailed to the the S&P 500 since the Great Depression: editor by the fifth of the month. Letters and March 1937 to April 1942, minus 60% comments are welcome. If you want to email an March 2000 to October 2002, minus 49% article about the fragile financial system, the Jan. 1973 to Oct. 1974, minus 48% status of energy resources or some other Oct. 2007 to Oct.9, 2008, minus 42% financial issue, you will have a chance to appear Nov. 1968 to May 1970, minus 36% in print and inform Pro Forma readers. Aug. 1987 to Dec. 1987, minus 34% Book reviews are welcome. Mail disks May 1946 to June 1949, minus 30% to: 319 Walnut Ave., Apt. 2, Long Beach, CA. Dec. 1961 to June 1962, minus 28% 90802, or use email to contact the editor at Nov. 1980 to Aug. 1982, minus 27% [email protected]. Feb. 1966 to Oct. 1966, minus 22% My home phone is (562) 437-2412. Aug. 1956 to Oct. 1957………minus 21%

7 Pro Forma

Pro Forma Editor William Parmenter Pro Forma Editor, Emeritus Orvis Adams

SIG GROUP CHAIRMEN

Asia Pacific Group Robert Hsu IBD Meet-up/ AAII CANSLIM Norman Langhout Mutual Fund Group Gunter Hagen Pasadena Group Ivan Wong Palm Springs Group Patti Gammino San Fernando Valley Group Evan Press Westside Computer Group Don Gimpel

Pro Forma is offered free of charge exclusively via email and is also available for downloading from the Los Angeles Chapter web site at: www.aaiilosangeles.org. The American Association of Individual Investors is an independent nonprofit corporation formed for the purpose of assisting individuals in becoming effective managers of their own assets through programs of education, information and research. Pro Forma is published for advising members of the groups' activities and for sharing information. All material compiled without verification of accuracy to a specific task or computer system. All material provided in the ewsletter is for educational and illustrative purposes only. Comments are the views of their author and no other person or organization. Investing is an inherently risky business. Investors may loose their entire investment or more. Past performance is not a guide to future return.