Malthusian investment strategies

Jim Rogers, the man who co-founded the Quantum Fund along with George Soros, is the kind of investment analyst everyone loves (to be) since he made enough money to retire at the age of 37 (during the ’70s, the Quantum Fund portfolio rose 4,000 per cent while the S&P rose less than 50 per cent), and has since dabbled in teaching finance, has taken an around-the-world motorcycle trip of more than 100,000 miles (that gave birth to Rogers’ first book, Investment Biker), and later a 152,000-mile trip in a “one-of-a-kind” Mercedes Benz across 116 countries and “through half of the world’s 30 civil wars”.

Makes him a sort of Ernest Hemingway of the investment banker circuit. Indeed, as Rogers tells us, he’s been right most of the time (he must have been to make that kind of money)—in 1998, when he saw that a lot of stock were heading south, he began talking of investing in commodities and how Chinese demand would fuel this.

This is the time when Merrill Lynch got out of commodity trading, the Dow Jones Commodity Index hadn’t been revised since the mid-’60s, the Reuters one since the ’30s, and the Commodity Research Bureau’s (CRB’s) Index gave the same weighting to crude as it did to orange juice!

Rogers’ theory, and therefore advice to all of us, is simple, almost Malthusian in its inexorability and the impact of the growth in population on demand: as countries like China grow (sadly, Rogers is dismissive of India), their demand for steel, oil, fertilisers, and even lead will rise dramatically.

So anyone investing in commodities just can’t lose. China’s import of scrap, for instance, has doubled since 2000, and is likely to double again by the end of the decade, copper import rose 25 per cent since 2001, and oil consumption rose from two million barrels a day in 1987 to 5.4 million by the end of 2003—the list goes on.

What makes things even better is the independent research Rogers marshals to support his thesis.

A study from Yale University, for instance, shows that returns from commodities were negatively correlated with returns from equities and bonds (so if stocks go down, commodities will rise), commodities have less risk in comparison, and the returns from investing in commodities directly were three times the returns got from investing in stocks of the companies that produced those commodities (buy steel, not Tata Steel!).

Rogers cites instance after instance of periods in which stocks rose and commodities fell and vice versa, cases of when the economy was in trouble but commodities rose (in the ‘70s, economic growth was poor globally but oil prices rose 15 times), and cases where prices have risen even though demand has fallen (two of the biggest demand segments, paint and gasoline, stopped using lead over the past two decades, but lead prices are making new highs).

The reason for the highs is pretty easy to guess; as Rogers puts it, the world is “running on empty (again)”. While oil demand goes up inexorably, there has been no major oil find for the past 35 years, very few new mine shafts over the past two decades, and so on.

Typically, says Rogers, it takes 15-17 years for enough capacity to get set up before it outstrips demand and that’s how long the current cycle that began around 1997 will last.

Any book written after the kind of travelling Rogers has done has to be full of delightful insights and anecdotes, and this is no exception—did you know that Ghawar, the king of the Saudi oil wells which produces around 60 per cent of all Saudi oil, is 90 per cent depleted? For those who’ve still not got a grip on market jargon, Rogers has excruciatingly simple explanations of how things work and of jargon from “stop loss” to “contango”.

Here’s how leveraging works and also bankrupts you:

Let’s say you buy, in February, futures contracts for 5,000 units of soyabeans at $5 apiece in August, and make an initial margin payment of 5 per cent or $1,250. If prices rise by 50 cents in May and you sell your futures, you make a profit of $2,500, or double your money.

If prices go the other way, you lose $2,500—you lose double your money while bean prices fell just 10 per cent.

The problem with books such as this one, however, is that in an attempt to lure people into the market (this book’s subtitle is “How Anyone Can Invest Profitably in the World’s Best Market”) life is made out to be almost risk-free—sure there are the usual caveats but selling snake oil’s a piece of cake for an accomplished investment salesman.

As with stocks, research is everything (Rogers recommends the CRB Commodity Yearbook to get detailed historical demand-supply charts), as is detailed knowledge of tiny things like the weather (the 1994 “double frost” in Brazil made coffee prices triple), and the instinct to figure out whether technological breakthroughs will impact prices (the invention of the Hughes diamond drill in the 1960s dramatically changed the prospects for oil supplies, but instead of falling, oil prices went up by more than 1,000 per cent between 1965 and 1980).

In other words, it’s a great book, but no one’s become an expert by reading just one book.

Postscript: I may be biased, but Rogers’ stories and analysis look somewhat suspect given what he says about India—“we had to buy a different mobile phone in almost every city (in India), while in China our cell phones worked everywhere”.

Hello, what’s Rogers been smoking? No one’s ever had this problem unless he bought a Reliance phone in the days it was meant to offer only limited mobility.