Sunday, June 10

Week 49 - Commodity Index

Situation: Before investing in commodity producers, it is useful to look at an index of economic activity in countries with the highest demand for commodities (US, China), and an index of commodity prices (e.g. Dow Jones UBS Commodity Index). Commodity prices are extra-vulnerable to economic winds because the costs for up-grading production are large and lead-times are long. Commodity prices therefore depend not only on the strength of the economy in end-user countries but also on a ~35-yr “supercycle” that reflects expansion of production when commodity prices are high, and “slack” when the supply of the commodity finally becomes plentiful. This slackening usually coincides with a fall-off in demand that is frequently related to constraints on credit. You, however, are a long-term dividend re-investor who is interested in owning stock in commodity-related companies, not futures contracts. As such, you need an index of stock prices that includes dividend payouts. 

To construct our index, we selected 8 of the most solvent, well-established and dominant players among commodity-related companies tracked by Standard & Poors (for background info see Week 40, Week 42, Week 45 & Week 48). Two are based in Canada (SU & CNI) and the rest in the United States. Four are oil & gas producers: Suncor Energy (SU), ExxonMobil (XOM), Chevron (CVX), and Schlumberger (SLB). One company mines gold and copper (Newmont Mining - NEM), one produces heavy equipment used on farms and at mining and drilling sites (Caterpillar - CAT), one is a railroad that gets ~90% of its revenues from transporting commodities (Canadian National Railway - CNI), and one produces genetically engineered seeds and matching herbicides (Monsanto - MON).

The baseline investment for the ITR Commodity Index is a "virtual" purchase of 100 shares of each of these 8 companies at the close of business (COB) on 7/1/02 (transaction costs not included), which had a cost of $30,353. At COB on 6/6/12, that “virtual” investment had a market value of $109,256, and had generated $13,043 in dividends over 10 yrs, for a total return of $122,299 (15.0%/yr). During the bear market of 10/1/07 through 4/1/09, stock in those 8 companies fell an average of 32.0% in value. The dividend yield for the index is currently $2,448 (2.24%/yr), which means the original investment of $30,353 now pays 8.1%/yr. Presently (and since the beginning), CVX, CAT and CNI have been the most valuable components of the index and now pay 62% of the dividends. Because of stock splits, the index now holds 200 shares each of SU, CVX, CAT, MON, SLB and 300 shares of CNI, as well as the original 100 shares each of XOM and NEM.

Bottom Line: Commodity-related companies anchor most portfolios that outperform a broad-based stock index. However, the ups and downs can be disheartening so it helps if the investor has some idea of why that is happening and whether it is attributable to “the usual course of doing business”. To assist readers of our blog, we have set up a stock price index for 8 prominent commodity-related companies. The index started at a value of $37.94/share on 7/1/02 and has a current value (6/6/2012) of $72.83/share, thus it has grown almost 14%/yr. For comparison, the Dow Jones UBS Index of raw commodity prices has grown 3.8%/yr. In other words, someone who owns stock in companies that turn raw commodities into useful products is likely to accumulate wealth much faster than someone who invests in commodity futures.

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