The Commodity Investor Q&A
With Matt Badiali
October 1, 2008
Q: It seems like all commodities are struggling. What's the Armageddon strategy for natural resource investors? – A.H.
A: Back in April, when oil was $110 and climbing, I told DailyWealth readers that the key to making money in oil stocks this year was to sell 'em.
The boom was entering mania mode. The best thing for investors to do in that situation is ride their stocks with a sharp eye on their trailing stops. That advice worked out well for oil investors this year. They enjoyed the boom... and then cashed out before the bust took them for a round trip.
Remember, selling is the only way to realize your profits.
The same advice holds in a bear market. Sticking with your discipline and selling at your stops is the best way to cut your losses.
Selling sounds easy, but I know the majority of investors get way too attached to their stock holdings... both the winners AND the losers.
Take small mining stocks for example... The Toronto Venture Exchange, home to most of those companies, peaked in May 2007. Since then it's down 52%. That means their average performance is -52% in about 18 months.
Most of the folks I know are much worse off than that. They held onto losers like dying pets. Now they are sitting on 80% losses with little hope left.
My good friend in Vancouver, the world capital of natural resource stocks, is an investor-relations pro. And he made a bundle in those little miners in 2005 and 2006. He bought companies at 25¢ and rode them to $1.50 or more.
But he let that success go to his head.
During the last eight months, he gave almost all the money back because he refused to sell. "I just figured they would come back," he said. "I averaged down along the way. Now my investments are worth 20¢ on the dollar."
That's a huge hit to his retirement account. In fact, it will take years to fix that particular blunder, if he ever can. My friend could have kept a big chunk of money by having a stop-loss strategy and following it.
If you're still hesitant to sell a stock after it hits your trailing stop or even starts a downtrend, remember folks who held their Internet stocks for years. You should know by now, even the strongest uptrends have shakeouts along the way. You can't know how severe they'll be, so you simply have to stick to your plan, take your money off the table, and move on.
Commodity investors may feel like it's the end of the world right now. But if you preserve your cash and be patient, you will likely see a once-in-a-century opportunity to buy great companies at bargain prices.
Q: Why are iron ore producers getting hammered? – A.L.
A: Iron ore producers are getting hammered because steel prices have buckled.
Iron ore and coking coal are the two biggest ingredients in steel. Raw iron ore comes from Brazil, India, Australia, and North America. But it really has one buyer: China. So as the Chinese steel industry goes, so does the global iron ore industry.
This spring, when business was booming, the Chinese signed landmark agreements, promising to increase iron ore prices 65% to 100% over last year. That put premium iron ore around $140 per ton.
But Chinese steel production fell 5% from July to August, as opposed to the 14% growth in July 2007. It's a clear signal that the times, they are a-changing. That combined with high coal prices mean Chinese steel mills can't meet the prices they promised for iron ore, and they're defaulting on their contracts.
Companhia Vale do Rio Doce (RIO), the world's biggest supplier of iron ore, is down nearly 60% since May. It might seem like an attractive buy at these levels. But I think we should sit on the sidelines for a while. Things could get worse from here.
Good investing,
Matt
