Here's a question I get asked all the time by friends, colleagues, and attendees at the investment conferences I speak at:
'Why do you gravitate more toward the commodity market, while trying to stay away from stocks?'
Great question. And a simple answer for it.
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While many people make a pretty good living trading stocks, and have increased their net worth, I've personally found that in my 15 years of being a professional trader, the wealth I can build up from investing in commodities greatly surpasses stock market returns.
Let me explain why I think the commodities world offers more financial advantages than stocks - and with the April 15 tax-filing deadline almost upon us, tell you about one pretty big tax break that you get from investing in commodities, too...
Four reasons not to invest in stocks
Remember... I'm speaking from personal experience here. By no means am I trying to dissuade you from trading stocks. I'm just giving you the reasons why commodities have worked for me over time.
And when I say the 'stock market,' I'm referring to individual stocks, not the broad market as a whole, as measured by the Dow Jones or the S&P 500. When I put money in the stock market, it's using investments that track the broader markets - such as ETF options on the Dow Diamonds Trust (AMEX: DIA), the Nasdaq 100 Trust Shares (Nasdaq: QQQQ) or the SPDRs (AMEX: SPY).
That's because when it comes to individual stocks, there are clear pitfalls...
Earnings Reports: We all know that every three months, publicly traded companies are compelled to release their quarterly earnings results. These announcements often cause a spike in volume and volatility and send shares up or down considerably.
Logic dictates that when a company reports blowout earnings, shares should soar. And when the numbers disappoint, the stock should fall. But it often doesn't work like that - not when investors are prone to 'buy the rumor; sell the news.' How many times have you seen a company report great numbers... only for the stock to drop like a stone? While it makes no sense, the reaction revolves around whether or not the company met analysts' earnings projections. This makes no sense. More to the point... how do you trade profitably when things like that happen?
Government Reports: If it's not individual earnings reports, you've also got the uncountable array of government reports. GDP growth figures... the CPI and PPI inflation numbers... Federal Reserve interest rate announcements... employment data... real estate market numbers... manufacturing figures... retail sales results... consumer sentiment. The list goes on. And with each announcement, stocks can react unpredictably and irrationally.
Underhanded Executives: Just when you think a company is rock solid, it suddenly implodes because one or two shady executives are cooking the books at the shareholders' expense. Enron is a prime example, and we've also seen other high-profile companies like WorldCom, Adelphia and Tyco collapse for this reason.
I know this is a very small fraction of all the companies on the stock market. But the fact remains that the stock market isn't as safe as it once was. Do you ever truly know if these guys are running the show properly, or abusing your hard-earned money?
Analyst Opinions/Brokerage Grades: If you're looking for a short-term spike or fall, you can trust the thousands of analysts to provide one, simply by opening their mouths. Whether it's an upgrade or downgrade, whenever these so-called experts pass on an opinion, sheep-like investors often follow whatever they say. Trouble is... different research firms put out a different view of the same stock every week, which jerks the price around like a yo-yo. It's very difficult to get a true feel on how a company is doing.
These drawbacks are enough to make me think twice about investing too heavily in stocks and stick to the commodities markets instead. Here's why...
Four reasons to invest in commodities
The commodities market is one of the fastest-growing areas in the investment world. And it offers some major advantages over stocks that you might not have considered before. Let's take a look...
Outside Influences Are Minimal: With commodities, you're not investing in something that is bombarded by as many outside influences that the stock market is. Nor are you buying a piece of a company that is run by a few individuals. You're investing in raw materials and actual physical products that are used for everyday consumption.
We're talking about oil, natural gas, coffee, sugar, cocoa, orange juice, gold, silver, and copper. All these commodities trade on designated exchanges throughout the U.S., with most of them located in New York and Chicago. And the way you can participate in these markets is through the futures and futures options markets.
Commodities Aren't Run By Corporations: If you despise corporations, then the commodities world offers you a sanctuary. They're all free from corporate control. There's no boardroom drama. You're simply taking a position against the other side.
You see, there's one main economic driver that affects physical commodities: Supply & demand. That means the focus is on inventory levels and growing cycles.
For example, will a drought in the Midwest affect corn and soybeans? Will hurricanes in Florida and the Gulf of Mexico hit natural gas and orange supplies? Will frost in Brazil lower the coffee crop? These are just some of the factors you need to take into consideration when investing in commodities.
And since weather forecasting technology has become more sophisticated, we can make better predictions about the future direction of these commodities.
Commodity Price Moves Are More Predictable: Having been in the trenches as a NYMEX market maker, I can tell you from personal experience that price movements in the commodity markets - whether up or down - are much more predictable and methodical.
This is because when you don't have so many sources spewing out conflicting data, you get a better handle on the moves.
And even though large hedge funds have invested heavily in commodities lately, they haven't had a long-term directional affect on the markets. Yes, they can push a market up temporarily, but the commodity markets are so large, they can encompass all types of players pretty seamlessly. So when it comes to chart analysis and looking at inventory and growing cycle data, it makes for more predictable movements.
You Get A Better Tax Break When Investing In Commodities: Another compelling reason to invest in commodities is the favourable tax treatment they receive, compared to stocks and stock options.
Since many of us trade on a short-term basis (less than one year), commodities and commodity options have all their short-term gains split on a 60/40 basis. That means 60% of short-term gains are taxed at the lower, long-term capital gains rate, while the other 40% is taxed at your higher, ordinary tax rate.
Compare this to stocks where all short-term stock gains are taxed at your ordinary tax rate - sometimes as high as 39%! That makes a huge difference come tax time. However, remember to consult with a tax professional before jumping head first into commodities, just so you're clear on the situation.
All these factors add up to why I like commodity investing over stock investing. I've been doing it very profitably for 15 years - and plan to do it for many more.
By Lee Lowell, Futures Options and Commodities Specialist, Mt. Vernon Research for the Smart Options Report, www.smartoptionsreport.com
