Day, Investing in Resources

Anyone thinking about adding commodities to his portfolio, especially gold, would do well to read Adrian Day’s Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks (Wiley, 2010). It is sensible, well documented, and written in fluid prose.

Day is a gold bug, arguing that the precious metal is “the asset of choice for the next few years.” For one thing, it will perform well in a variety of scenarios; it is not subject to the “major risk associated with the resource complex, namely slowing demand from a major recession.” (p. 79) In fact, Day identifies fourteen reasons for gold to continue to go up, from monetary instability and reflation policies to supply and demand imbalances.

Let’s assume that we buy into the thesis that we are in the midst of a commodities super cycle yet know that commodities can be extremely volatile. What is the best way to gain exposure to commodities and at the same time control risk?

Addressing the second question first, Day suggests that investors divide their commodity investments into a core portfolio and a trading portfolio. “The core is intended to provide exposure to the broad complex for the duration of the super cycle. Here you will buy with less regard to price, hold for the long term, and accept volatility. In the trading portfolio, however, price is more critical, you will hold for shorter periods trying to maximize gains, and you will attempt to use volatility to your benefit. The goals are different: One is intended to provide certain exposure to the sector for the duration of the cycle, so what you own is critical; the other is intended to maximize gains from the sector, so how and when you own is critical.” (p. 125) Sometimes the same stock is included in each portfolio. Indeed, one of Day’s favorite strategies is “to take a long-term position in a favorite stock and then trade around the edges.” (p. 126)

Day carefully assesses the various ways of gaining exposure to commodities. He looks at the pros and cons of holding physical commodities, primarily precious metals, including numismatic coins (“an area rife with ignorance and worse”). He points out a spate of problems with commodity ETFs—the not-insignificant drag on returns from the need to continually roll over futures contracts, their complicated and often unwelcome tax treatment, and CFTC rules that enforce daily trading limits and overall investment levels for various commodities.

He devotes three chapters to investing in mining companies: the major producers, the junior producers or developmental companies, and the explorers. For investors, he contends, “the selection criteria and investing tactics should be different for each group.” (p. 149)

After his detailed analysis of investing in gold and gold companies, Day then moves on to the other metals--silver, platinum, copper, and the base metals and rare earths. In the final hundred pages of the book he looks at the energy sector and, briefly, at agriculture. He concludes with some suggestions for building a commodities portfolio.

Investing in Resources is a thoughtful, practical book for anyone who thinks that the commodity “Super Cycle” has years left to play out.