Cinco de Mayo!

Yesterday I stumbled across two unrelated posts that each offered important thinking points.

The first was from Niels Jensen via Credit Writedowns. Jensen had been very bullish on crude oil for many years starting in 2004 but now expects a meaningful drop in price although he is clear to point out that short term there could be more upside. As he notes this opinion is in sharp contrast to Jeremy Grantham's latest who expects big things for many commodities for quite a few years to come.

Jensen aligns himself with Dylan Grice who recently pointed out that the long term return in commodities is zero with an accompanying chart. Jensen also mentions that correlations between commodities and equities has gone up making the diversification benefit less useful.

There are important considerations before adopting Jensen's position. First let me say I do believe that commodity exposure in small doses can make for effective diversification but there needs to be a willingness to modify the exposure on occasion. Given my belief in moderation I think it is fair to say I am no perma bull.

The long term return being zero, yes the chart goes back to 1871 and bears that out. However there have been periods where the returns have been very good and other periods where the returns have been lousy. They were lousy from about 1980 until about 2000. One theory I have for this, and this is supported by Grice when he says buying commodities is selling human ingenuity, is that we saw meaningful gains in technological innovation benefiting developed markets during those 20 years. During this decade as commodity prices have gone up a lot we have seen less society altering innovation but have seen that innovation from the 1990s spread across the developing world as prosperity as spread to those markets. This prosperity and spreading of innovation has caused greater demand for all sorts of resources and demand is still expanding because the prosperity is still expanding.

Obviously we should layer in what is going on in the US with the Fed, the debt and everything else that has created increased awareness and demand for precious metals.

I have no idea when the recent good times for commodities will end but I would expect that won't happen for a while and a big contributing factor, whenever this occurs, will be some sort of globally transformative technology. The important thinking point is to zoom out a little bit to understand what is really behind a theme and to spend time digging in to what makes a theme work and what obstacles are likely to derail the theme. This is obviously part of the top down process.

The next post was titled 9 Critical Questions Investors Must Consider by Kevin Prendergast. The most interesting to me was "which assets are most likely to make money over the next few years? Which should be avoided?" Obviously I place great importance on figuring out what to avoid. Occasionally, figuring out what to avoid (or at least underweight) is very easy like when a sector grows larger than 20% of the S&P 500 or extraordinary and desperate measures being taken to keep things afloat. Another more anecdotal indicator might be an abundance of TV shows on a subject--it seemed liked every cable network had multiple house flipping shows for a while.

This too is a top down idea. One benefit is is that it takes a lot less work to rule something out than to decide to buy in and on a personal level I believe this is easier to do than figuring what to go long.

Finally a personal item; I was named to a Who's Who of Wall Street list in the category of Top Wall Street Experts and Opinion Leaders. There are a lot of names on there but it is kind of neat.