Gold and Energy Correction: What to Do

A lot of people are wondering what to do about the latest correction were seeing in gold and energy. Should you run? Buy more? Stand pat?

To give you some answers, Ive asked Steve Chapman, Vice-President of Weiss Capital Management, Inc., to tell you what hes doing for their clients.

Weiss Capital Management is a separate affiliate in our Weiss Group, registered with the SEC since 1989 and managing close to $400 million in assets.

And in the Weiss All-Star Growth Program which Steve manages, the performance is 39.06%. To be exact, thats the cumulative total return from inception (August 6, 2004) through the end of last year, net of fees. On average, 26.5% per year.

Naturally, what happens from this point forward is unknown. And his excellent performance doesnt mean you should take everything he says as gospel. But if you want straight, no-nonsense insights and ideas on what to do, I suggest you listen to him carefully.

What Im Doing (and Not Doing)
About This Correction in Energy,
Gold and Other Natural Resources
by Steve Chapman

Its already been four months since we got hit by Hurricane Wilma here in South Florida. But when I drive to work every day, I still see nothing but blue roofs on home after home the signature blue tarps covering gaping holes that have yet to be repaired.

My home also got hit, and were still waiting for the insurance check to come through so we can begin the repair process. As you can imagine Ive been having one heck of a time trying to get through to my roofer. Basically its take a number.

I finally got in touch with him this week. He says hes so swamped with work hes pretty much taken his phones off the hook.

Is this because the hurricane was so bad? Yes, but weve been through hurricanes before, but it never took this long.

Rather, what this and other signs are telling me is that basic construction materials like lumber, aluminum, tar, cement and copper are in a supply crunch all over the world. Theres just very little slack out there for things like hurricane repairs.

And believe me, you dont want to sit around living with a hole over your head and rain pouring into your house. You gotta pay what you gotta pay.

I have a friend in the construction business. Hes had so much trouble getting cement and other materials on a timely basis, hes had to go all the way to Brazil to get some. No, he didnt have to go in person. He just bought what he needed over the Internet, and they drop shipped it!

He also tells me that many contractors he knows are filing for bankruptcy. But its not a sign of bad times or poor sales. Its because the cost of building materials has gone up so fast, its cheaper for them to for file Chapter 11 than to deliver the units they originally contracted for at lower prices.

In fact, materials prices are going up so much that my own home insurance adjuster told me to expect the settlement checks for my own home in at least two stages. She said, Well be giving you a first check soon, but we know that, a few months from now, when you get your final repair bills, youre going to be looking for a second check to cover the difference. Everybody, including the insurers knows the score costs are going up!

This is the continuing reality of our times. It shows no signs of changing any time soon. Moreover, costs are being driven by a far more powerful force: the burning desire of the worlds largest populations to better their lives.

My feeling: Living with a roof in temporary disrepair is nothing in comparison to the living conditions theyve endured for decades, even centuries. Now, more than two billion people in China, India and neighboring regions are finally seeing the opportunity and are beginning to have the income to change all that.

So the little spurt in demand for construction materials were seeing in South Florida is just a drop in the ocean compared to the big, long-term thrust were seeing for construction materials overseas.

80% of The Worlds Population Lives in what we refer to as Emerging Markets yet only contributes 20% of the Global GNP!

I think that certainly puts some numbers behind the story. It shows you how big and sustainable this growth pattern is likely to be.

In years past, it was the rich nations just one-fifth of the worlds population that were the primary drivers of the world economy, that made the difference between rising basic materials markets or falling basic materials markets.

Now, more and more, its the other four-fifths of the worlds population thats coming on line and making things happen. Thats big. And its not going to change just because some speculators in New York or Chicago or elsewhere decided last week to sell instead of to buy.

What about the weaker housing situation in the United States? Will that reduce demand? Perhaps. But thats not whats been mostly driving the price of raw materials and natural resources higher.

Massive Demand Still
Pouring in From China

Among our clients at Weiss Capital Management, is a couple from Michigan. They live in one of those cities where the steel mill was the heart and soul of the local economy … until the mill began to wind down and the prosperity of the city along with it.

Then, one day not long ago, some Chinese business people came to town inquiring about the mill. Essentially they said: If you put that plant back on line, well buy all the steel you can make.

So now theyve done just that, and the heart of the city is pumping again. Instead of Detroit being the big customer, its China.

Why do the Chinese need all the steel they can lay their hands on?

One reason is their boom in automobiles. Just over the past decade, Chinas automotive industry has grown at a phenomenal clip. As late as 1990, China produced only 42,000 cars. Next year, China is expected to make over 6 million cars and trucks. It will actually overtake Germany to become the third-largest vehicle manufacturer in the world.

Until recently, Chinese cars were poorly built, assembled by hand using low-cost labor. Even their steel was being poured into molds by hand. Now, Chinese automakers have been aggressively acquiring advanced technology, mainly through foreign joint-ventures. That alone has caught them up a quarter-century.

The other reason is the Chinese building boom. People who go to China come back saying that China has a new national bird: the construction crane. And its true. The equivalent of one city the size of San Francisco is built in China every week!

The same is happening in other Chinese industrial sectors. Something similar is happening in India and even dirt-poor countries like Bangladesh. South America is also coming up quickly. Among the worlds continents with people on them, only Africa is being left behind.

The end result: A continuing, growing demand for basic materials.

How to Invest in the
Basic Materials Boom

To take advantage of this situation, one mutual fund I like is Jennison Natural Resources Fund.

There are currently 148 natural resource funds available out there according to Morningstar. And among them, so far this year, this fund is among the top 10 in performance, as of 2/15/06. Last year, it returned 54.2% to investors. Or course, no one knows what its going to do this year.

A drawback I see with Jennison is that it has a front-end load of 5.50%. But for investors in our All-Star program, the load is waived a huge benefit, I think. (Of course, the funds still have expenses, which you pay.)

If youre currently invested in pure energy funds, you may want to further diversify into one that has a sizable stake in basic materials as well, like this one, provided its suitable to your goals, of course.

Why? Because you cant judge a book by its cover. Sometimes, a fund that has natural resources in its name is really just another energy fund. If you were to buy it, instead of diversifying, youd unwittingly be doubling up. So before you invest, you need to drill down to its actual portfolio holdings.

I see quite a few natural resource funds that are 80% or even 90% energy. So if you want other natural resources, do your homework and make sure thats what youre getting.

Deeply Undervalued
Latin American Markets

Right now, S&P 500 companies are selling for an average of 18 times their earnings.

By contrast, in Latin America the average P/E ratio is about 11 times earnings, the lowest of all emerging market regions. Compared to their U.S. counterparts, thats like buying assets for less than 61 cents on the dollar.

And yet the growth rates in those areas are much faster. So what explains the discrepancy? Why are those markets so undervalued?

One reason is that when you buy in the United States, you are paying a high safety premium. When you buy in emerging markets like Latin America, you get a deep risk discount.

There is indeed more risk when investing in emerging markets. For example:

You have the currency risk the possibility that the value of the money will tank.
You have market liquidity risk the chance that you might have trouble selling if the stock is thinly traded and too many investors rush out in a hurry.
And you have the political risk such as a revolution or coup detat.

But I think most investors today are still in the 20th century, still guided by the precepts of the cold war, and may be significantly overestimating those risks.

Now, dont get me wrong. You can lose money on these investments. But today things are different than they used to be. I believe that, if investors would just focus on the 21st century and look more at the current conditions on the ground, theyd see:

Some Latin American currencies that are actually stronger than the U.S. dollar, moving more or less in tandem with the Canadian dollar and the Australian dollar.
Financial markets that are larger and more mature than they used to be, plus many companies that trade on U.S. exchanges with the same kind of volume and liquidity as many of their U.S.-based counterparts.
And governments that are quite pragmatic, that have been upgraded by the major rating services, opening the door to institutional investors.

Its funny that investors today dont think twice about investing in Chinas growth. And yet China is a communist country, with a political philosophy that is far further to the left than any country in Latin America.

The big issue today is not so much left or right, as it used to be. Its stability. And that goes for any country, including those in Europe, Asia or Latin America.

I like the Fidelity Latin America Fund, and its been in the Weiss All-Star Growth Program since June 2005. Volatile. But good.

Two Other Opportunities:
Japan and Eastern Europe

Just the other day, a group of Japanese portfolio managers flew in from Tokyo and stopped by our office here in Palm Beach Gardens.

They manage $12 billion of Japanese securities and are among the biggest money managers in Japan.

Their view: Dont invest just in the Nikkei average. Instead, look at the specifics of each company on the ground. Then cherry-pick the best ones.

And guess what: According to Morningstar, their fund, SPARX Japan Fund, was the #1 Japanese fund in 2004, up 35.5%. Last year, it was 50.4%, in the top five.

I saw the Japanese market turning around in 2004. But after watching Japan languish for over a decade, I figured I couldnt trust just one year. So I waited until last year before buying into Japan for clients in our All-Star program.

Another alternative: If you like exchange-traded funds, you can use Ishares Japan (EWJ). But personally, I prefer a research-driven mutual fund like SPARX.

I also like Eastern Europe, especially the Metzler Payden European Emerging Markets Fund, which specializes in countries like Russia, Hungary, the Czech Republic, Poland and Romania.

As I see it, whats happening is not rocket science: The have-nots in Eastern Europe are quickly ramping up to the level of the haves in Western Europe.

And they have almost everything in their favor: A mature culture. A highly educated population, with high school test scores ranking at the top of the worlds charts. And perhaps most important, that intense, burning desire to finally better their lives.

And now, turbo-charging their growth, capital-rich companies and investors in Western Europe are moving in to acquire the best of the lot. The Western Europeans are saying: Look. Theyre our neighbors. They work for a lot less. They know what theyre doing. Lets buy the cream of the crop.

What to Do Now

Weve had a great run in these two areas natural resources and emerging markets. These are the markets that have made some investors very wealthy.

But along the way, weve seen one correction after another. And each time that happens, we ask ourselves the same questions youre probably asking right now: Is this the time to get out?

As I see it, there are only two situations in which the answer would be yes.

The first situation is if your investment goals have changed.

I tell my clients: All-Star is an aggressive program. If youve netted 26.5% per year in my program … that also implies the possibility that, if we had been wrong every time we were right, and we took no protective steps, you could have been down 26.5%. If that thought frightens you, transition to more conservative investments. For example, put your money in Treasuries, either on your own or with our Weiss Treasury Only Money Market Fund.

The same applies to you.

But if your goal is to continue growing your money, I think you should stick with it.

The second situation is when we have concrete evidence that the world economy is stumbling and heading into a recession. Never forget: The strongest, most consistent force thats been on our side has been the world economy. But I see no evidence thats slowing down.

China, India and emerging markets are still going gangbusters. Even the U.S. economy, which seemed to be faltering a bit in the fourth quarter, is now perking up. You saw the big jump in retail sales Tuesday. And that was despite the big energy bills consumers are paying.

My view: When a race car stops to refuel, it doesnt mean the race is over. Thats what I think were seeing in some of these markets right now.

Also please keep in mind that you cant completely protect yourself from the ups and downs. But heres what I do to help smooth out some of the volatility for my clients.

First, I diversify across multiple markets around the globe, and in what I feel are the best sectors here in the U.S. My experience is that when one is going down, the other is often going up.

Second, make sure you have protection against a decline in the dollar.

Third, include natural resources. Its an inflation hedge and a good offset to some financial assets that might be going down.

Fourth, you cant just lock your money away and forget about it. I watch it daily and our clients get full reporting monthly, or any time they want to call in and talk.

My advice to readers: Before you invest in anything, to thine own self be true. If youre not, your investments could end up owning you rather than you owning them.

And before you do anything based on this e-mail, be sure to carefully read our important disclaimers.

Best wishes,

Steve Chapman
Weiss Capital Management
800-814-3045
E-mail: schapman@weissinc.com

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

Sign Up Free