Sunday, December 24

Week 338 - Alternative Investments (REITs, Pipelines, Copper, Silver and Gold)

Situation: You want to minimize losses from the next stock market crash. News Flash: The safe and effective way to do that is to have 50% of your assets in medium-term investment-grade bonds. Those will go up 10-25% whenever stocks swoon. But a plain vanilla form of protection won’t resonate with your neighbors after the crash hits. You’ll want to tell them about something cool that you did to protect yourself. And, while waiting for the next crash you don’t like the low interest income that you’d receive from a low-cost Vanguard intermediate-term investment-grade bond index fund like VBIIX or BIV. The exotic-seeming alternative is to bet on something related to land and its uses. Those bets carry valuations that track long supercycles, which overlap 3 or 4 economic cycles. But supercycles contain pitfalls for the unwary, and even for professional commodity traders.

Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.

Execution: see Table.

Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors. 

Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.

Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.

Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS). 

A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver. 

Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above). 

Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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