2011 Stock and Commodity Analysis: Forecast & Advice

Robert Boshnack, Chairman, Vision Financial Markets
January 2011

The year 2010 saw gains in commodities which outperformed stocks, bonds and the U.S. Dollar. A combination of growing investor demand for hard assets and an increasing appetite for raw materials in emerging economies propelled most commodity prices sharply higher.¹

Gains in the Commodity Research Bureau ("CRB") Index were led by cotton, which surged 92%,² silver (the precious metal most used in industry) jumped 84%; corn climbed 52%; coffee shot up 77% to a 13-year high as inventories shrank and bad weather threatened crops in South America; and sugar rose 19%.³ Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

We believe the increase in demand for commodities can mainly be attributed to three factors:

• Accelerating demand for commodities by a rapidly growing, consumerconscious middle class in emerging markets, most notably those of China and India.
• Excessive money printing by central banks, with a resulting debasing of currencies, increasing in debt and heightening in inflationary expectations.
• Destructive weather patterns on a global scale affecting crop harvests.

This "perfect storm" of fundamental factors all combined to propel commodity prices to record levels not seen in decades.

Emerging Market Demand: The China Factor

China, the world's most populous country at 1.2 billion people is going through a process of urbanization and is literally building its economy — virtually from scratch. China must, out of necessity, rely upon a huge amount of resources in support of its explosive rate of growth. For instance, an eye opening 40% of global demand for many metals can be accounted for by this Asian behemoth!⁴

While China's growth is expected to be about 9% this year, that will still amount to three times the rate of the U.S. and six times that of the euro zone, based on Bloomberg surveys of as many as 69 economists.⁵

Bear in mind the world is home to 3.4 billion Asians compared with 300 million Americans! In our opinion, it's not difficult to imagine that, from a base of 3.4 billion, an increasing Asian middle class will, in all probability, underpin and strongly foster upward pressure on commodity prices for years to come.

Sovereign Debt and Money Printing

Barton M. Biggs, former chief global strategist at Morgan Stanley, is presently a money manager running Traxis Partners, a multi-billion dollar hedge fund based in New York City. According to Biggs, on September 10, 2008 just before the collapse of Lehman Brothers, the Fed held $480 billion in securities. By October of 2010, that figure soared to $2.4 trillion.....a 400% increase!⁶ This is due to the Fed adopting the monetary policy known as Quantitative Easing. (Quantitative Easing is the policy wherein the central bank prints more money which it uses to buy government bonds and other financial assets, in order to increase the money supply and the excess reserves of the banking system.) Would you think any country whose monetary base increased 400% in just two years would ultimately experience the ravages of inflation? We believe the noted economist, Milton Friedman, was correct in his thinking that when the Central Bank prints too much paper money inflation results.

Historically, what has been one of the greatest beneficiaries of an over-zealous printing press? We can print money, but we can't print commodities!

Gold Outlook

After two decades of being net sellers of gold, central banks have resumed the policy of storing some of their wealth in the precious metal as a hedge.⁷ We believe that many savers concerned about their savings and the risks posed by the depreciation of paper currencies are diversifying into gold.⁸ Gold has risen 40 times against the U.S. Dollar in the last 40 years and almost six times in the last 11 years. Less than one percent of world financial assets are invested in gold and gold stocks.⁹

Hedge fund manager John Paulson believes that the U.S. faces double digit inflation within two and a half years. Paulson profited more than anyone else from the financial crisis in 2007, breaking every record with a $3.7 billion payday in 2007 while earning $15 billion for his firm Paulson & Company. He is currently very bullish on gold and believes over the longer term its price will move in direct correlation with the monetary base.^10,11 Credit Suisse believes gold prices could rise by 22% in 2011 as uncertainty surrounding the impact of increases in the U.S. and global money supply continues to support precious metals.¹² It should be noted that although the price of gold made record highs in 2010, to equal its 1980 inflation adjusted high, gold would have to reach around $2,300 per ounce.¹³

Weather and Its Impact

Byron R. Wien, the Vice Chairman of Blackstone Advisory Partners, believes rising standards of living in the developing world will seriously increase the demand for agricultural commodities. He predicts the price of corn rising to $8, wheat to $10 and soybeans to $16. He also predicts commodities will become a component of more institutional portfolios. Add to his prognostications the variable that is Mother Nature.¹⁴

Last year saw a drought in Russia that sent wheat prices soaring and corn and soybeans along with it. By year-end, corn prices were up 93.5% from June lows, and ended the year up 51.8%. Wheat and soybeans in 2010 gained 46.7% and 34.1%, respectively. Add in the flooding in Pakistan that cut its cotton harvest and contributed to a 92% increase in the price of the fiber.¹⁵

The Department of Agriculture reports that corn stocks are the second-tightest, which we believe will make prices highly susceptible to sharp increases based on jumps in demand or weather- related issues. 14 Alberto Weisser, chief executive of U.S.-based Bunge, one of the biggest traders of agricultural commodities including soybeans, told the Financial Times (December 29, 2010) that tight grain conditions would continue into the next year.¹⁶

There is a reason weather patterns were so harsh and extreme this winter. According to the Browning Newsletter on climatology it was due to La Nina and Kamchatka (Kamchatka is volcanic activity in the Kamchatka Peninsula in Russia). The Pacific is going through a cooler period, called La Nina (with this one being particularly strong) and the Atlantic is going through a warmer period. This would normally change weather patterns in rather predictable ways. But then throw in the Kamchatka volcanoes, which are throwing massive amounts of dust into the air, causing the Arctic to be even colder and Arctic winds to push farther south and you get a very drastic change in patterns as witnessed in 2010.¹⁸

Australia's wheat crop is down by 10%, but the bulk of it has been so damaged by the worst rain in a hundred years (by far) that it can't serve as food for humans and can only be used to feed animals. Throw in the drought in Russia mentioned above, severe drought in Argentina, floods in Brazil and Venezuela, odd weather in the agricultural parts of China, and you get rising food costs all over the world – all of which happened in 2010. According to the Browning Newsletter there is a real possibility of this weather pattern repeating in 2011. This could create a significant rise in grain prices especially in view of emerging nations rising demand and how low grain stocks currently are.¹⁹

Secular Bull Market and Bear Markets

A secular bull market rises over 15 to 20 year periods, where a secular bear market makes little progress. Commodities are in a secular bull market. Stocks are in a secular bear market. This can clearly be seen from the statistics below.

The secular bull market in commodities began in 1999. From its January 1, 1999 opening price of 134, through its December 31, 2010 closing price of 638 the Goldman Sachs Commodity Index (GSCI) rose 372%. During that exact same time period, the S&P 500, from its January 1, 1999 opening of 1229 through its December 31, 2010 close of 1258 rose two-tenths of one percent. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

It is interesting to note that even with two positive years back to back in 2009 and 2010 the S&P has made no progress from its 1999 close. That is what secular bear markets do; they rise and fall over long periods, making little or no progress.

Secular bear markets have proven particularly harmful and unrewarding for buy and hold investors. We have experienced three since the turn of the last century and are currently in our fourth. The average length of previous secular bear markets was 18 years, each lasting anywhere from a minimum of 16 to a maximum of 21 years.

It is also very important to recognize, longer term, within secular bear markets, there also exists cyclical bull markets like the one experienced from 2003 through 2007 and again in 2009 up to the present. Some of these cyclical bulls can be quite strong, leading investors to believe a new bull market has begun. While these cyclical bulls can last anywhere from one to several years, historically speaking, they tend to surrender their gains as the secular bear market re-emerges. We experienced this most recently in 2008, as the secular bear re-emerged with a vengeance, wiping out all cyclical bull market gains of the past five years, and bringing stocks back to levels of 1997!

Some of the biggest bear market rallies and cyclical bull markets occurred in the Depression years. After the Dow dropped four years in a row from 1929-1932, falling 89% (248 to 59), it had one of its best performance periods during a cyclical bull market within a secular bear market (1933-36). During this period, it rose to 179, only to fall back 32% to 121 in 1937. It took another 17 years to breach its 1928 high of 300, reached before the secular bear market began in 1929.

In the secular bear market beginning in 1966, the Dow dropped 18% to 785. It was not until 1972 when the Dow finally broke 1,000, rising to 1,020. Then, in 1973 and 1974, the Dow dropped 17% and 28%, respectively, down to 616. The following years, the Dow experienced cyclical bull markets within the secular bear market, but it was not until 1982 before it closed above its 1972 high at 1,047.

We bring these facts to our readers' attention because we believe the current rally in stocks from 2009 to present is based on artificial government fiscal and monetary stimulation and not on strong fundamentals (as we believe the secular bull market in commodities is based on).

We strongly believe, when the primary secular bear market re-emerges in stocks the gains of the previous years will be lost — as they were in 2008. The big problem is no one will know for sure until after the fact whether the next downturn in stocks is a buying opportunity or the resumption of the secular bear market. We believe this to be another strong reason to diversify into commodities, specifically investments into managed futures, which use commodities as a trading vehicle, and which are uncorrelated with stocks.

2011 Stock Market Outlook

With the Federal Reserve committed to an easy money policy we expect more of the same in 2011 as in 2010, with stocks ending a volatile year higher in the range of 10% and commodities outperforming stocks. Be prepared for "rolling" debt crises in Europe to roil the markets, but not to derail the upward trend in stocks. However, the U.S. and Western Europe economies dependency on cheap money and deficit spending will one day have to be addressed. If that happens in 2011 we believe our positive forecast for stocks will be voided.

The biggest crisis we are concerned about in the euro zone looms in Spain. Racked by 20% official unemployment, a housing bust even worse than ours, and savings banks (the cajas) teetering on the brink, Spain could face a full-fledged crisis in 2011. Moody's warned last month that Spain's public and private sector needed to refinance almost $400 billion in debt this year. Spain is Europe's 4th largest economy dwarfing the size of Greece, Italy and Portugal.²⁰

2011 Commodities Outlook

Growing economies are likely to boost prices of most commodities in 2011 especially as the demand for food, metals and oil increases in the emerging markets. Bear in mind no market, no matter how strong it may be goes straight up. There are periods of corrections and consolidations which we fully expect to see in commodities. However, with our expectations that the same fundamentals that propelled commodities in 2010 will be in existence in 2011 we would view these corrections as buying opportunities at the appropriate support levels.

We expect a continuation of cheap credit policies from governments and central banks in Europe, Japan and, above all, the United States, where core short-term interest rates remain near zero. These policies, most critically the renewed turn by the U.S. Federal Reserve to so-called — quantitative easing are designed to boost national stock markets and business profits by providing banks and corporations with virtually free credit.

The Federal Reserve in November announced that it would purchase $600 billion in U.S. Treasury securities by, in effect, printing dollars…and if necessary will print more dollars to support the economy. This cheap-dollar policy has the effect of debasing the world's primary trading and reserve currency, thereby fueling inflationary tendencies around the world. This should be supportive for the commodities markets.

As we enter 2011 much of the same fundamentals that propelled commodities in 2010 remain in place: increasing demand for commodities by a rapidly growing commodity consuming middle class in emerging markets, particularly China and India; record money printing by central banks debasing currencies; and severe weather affecting crop harvests.

We believe these excerpts from a January 3, 2011 article published in Financial Express by Jayant Manglik best sums up the outlook for commodities in 2011:

2011 promises to be the year of commodities. Every global event in the last three years has either been triggered by commodities or has, in a roundabout way, led to increased influence of commodity prices on the macro-economic environment….. Commodity prices are dictated by demand-supply and today's circumstances point towards increased prices. Financial investment into commodities is also on its way up and many banks are becoming active just the way... it was three years ago. In addition, producers of commodities are not expanding production to meet new demand because they are not sure if the demand is sustainable — and in the short run this will put pressure on the supply side and aggravate the price situation. Given this situation, it appears that every investor must go overweight in commodities in his portfolio and the list should contain not just gold but also copper, cotton, crude oil and silver which seem set to ride the price wave in 2011.²¹ Be advised that trading futures and options involves substantial risk of loss and is not suitable for all investors.

Participating in Commodities: Our Recommended Method

We believe that one of the best ways in which to participate in the commodities markets may be through managed futures with professional money managers referred to as Commodity Trading Advisors (CTAs). In fact, according to Barclay Hedge, one of the oldest and most respected providers of alternative investment data, out of the total $1.78 trillion invested in alternative investment strategies managed futures surpassed all other investment strategies based on assets under management. Yes, managed futures are now investors' #1 choice of alternative investment strategy! Be advised that trading futures and options involves substantial risk of loss no matter who is managing your money. Such an investment is not suitable for everyone. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

As required by regulations, CTAs are registered with the Commodity Futures Trading Commission (CFTC) and are members of the National Futures Association (NFA), a self-regulatory organization authorized by the U.S. Congress in 1982. CTAs are professional money managers who manage an investor's assets using investments in the commodities markets, just as a stock portfolio manager would invest his client's assets in a variety of different stocks.

Unlike stocks, or long-only commodity ETFs, managed futures have the versatility and potential to capitalize on both rising and falling markets.

Major Misconception

In our opinion, investors often make no differentiation between commodities and professionally managed futures. Commodities are an asset class whose performance is measured by long only indices. Professionally managed futures are an investment vehicle which uses the commodity futures and options markets in an attempt to capitalize on a rise or fall in commodity prices. In professionally managed futures, performance results are more dependent on the skill of the manager, not the investment vehicle. For example, 2008 was one of the worst years on record for not only stocks, but also commodities: commodities fell 46%. However, professionally managed futures as an asset class were up 14% to 18% according to the Credit Suisse/Tremont Managed Futures Index and the Barclay CTA Index due to CTAs capitalizing on significant declines in commodity prices. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

Actual Performance Interaction of Managed Futures, Stocks and Bonds

In a brochure published by CME Group entitled, Managed Futures: Portfolio Diversification Opportunities, several studies point to the non-correlative nature of commodities versus stocks and the value of professionally managed futures. "Including up to 20 percent of total investments in managed futures funds," one of the studies suggests (see page 3), "enhances managed portfolio diversity and therefore promotes greater independence from general market moves." Read the entire study.

There have been studies on the actual performance interaction of managed futures, stocks and bonds going back 30 years that helped educate the public about professionally managed futures, thus enabling investors to be more objective in making investment decisions. See the presentation: Understanding Professionally Managed Futures, One of Today's Fastest Growing Investment Alternatives. Please be advised that trading futures and options involves substantial risk of loss and is not suitable for all investors. There is no guarantee of profit no matter who is managing your money. Selling options involves unlimited risk of loss.

We believe some of the most important studies include:

Slide #11: What is the Impact of Managed Futures in an Overall Portfolio? This study used the exact same sources of empirical data from the actual performance of bonds, stocks and commodities dating back approximately 30 years. This study was not based on academic theory. It was based on actual performance statistics. The results of the study showed managed futures increased performance and reduced risk in a portfolio of stocks and bonds over approximately a 30-year period. In fact, the portfolio with the most risk and least return didn't have managed futures. The portfolio with the least risk and comparative return had 37% in stocks and bonds with 26% in managed futures.

Slide #12: Worst Drawdowns in Comparison (1990-2008) Drawdowns, which are the largest percentage drops in the value of an investment prior to recovery, are shown to have been less steep than those for major global equity indices….around three times less than the S&P 500 and seven times less than NASDAQ.

Slide #13: The Benefits of a Diversified Portfolio with Managed Futures More evidence of the important role managed futures can play in reducing risk and increasing performance in a stock and bond investment portfolio. This slide displays how overall portfolio risk is reduced by almost 82% from -41.0% to –7.5% and the return also increases almost 20% from +7.4% to +8.9%. This is mainly due to the lack of correlation and, in some cases, negative correlation between some of the portfolio components in the diversified portfolio. There is even non-correlation between stocks and managed futures as the two markets move independently from each other.

Slide #14: Managed Futures Declines vs. a Traditional Portfolio During Stock Market Declines In every year since 1987 that the stock market experienced declines as shown in this study, except one, managed futures were positive while a traditional portfolio of stocks and bonds were negative.

Slide #15: Managed futures performance during the six worst stock market declines in recent history:

Correlation of Selected Asset Classes

Slide #16: Performance Results of a 30 Year Study Over the past 30 years, managed futures have substantially outperformed U.S. and international Stocks. Managed Futures over doubled the performance of the S&P 500 and outperformed the International stocks by over 6 fold. Investors should be aware that trading futures and options involves substantial risk of loss no matter who is managing your money. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

Individually Managed Futures Accounts vs. Commodity ETFs

Transparency: Managed futures provide complete transparency versus an Exchange Traded Fund (ETF) which is a unit of a large holding and thus offers no transparency. Investors have 24/7 access to trading activity and account information via a password protected Web site. Investors receive a trade confirmation with the details of each trade transacted in their account and also receive month-end account statements. ETFs are not required to report their holdings on a daily basis.

Bias: Perhaps most importantly, commodity ETFs tend to be LONG ONLY and thus eliminate one of the best advantages of managed futures by not allowing the investor the opportunity to profit in both rising and declining markets. One can see the disadvantage of this in 2008 when long-only ETFs suffered substantial declines while managed futures recorded double digit returns.²² Please be aware that not all CTAs experienced positive results in 2008.

Active versus passive management: ETFs are set and then passively managed to comply with their initial mandate. Managed futures provide active management that allows a manager not to follow the proverbial lemmings off the cliff based on their view of the market. ETFs also allow no opportunity to take advantage of a tactical tilt to gain additional exposure in a rising market/contract nor the ability to deviate and "take money off the table" when risk management so dictates. In addition, active management allows a Commodity Trading Advisor to take advantage of both rising and declining markets (as discussed above in "Bias").

Pooled vs. non-pooled funds: Each managed futures account is separate in the name of the individual, corporation or entity and not pooled together as in ETFs.

Consult your Vision affiliated broker for more information on the CTAs we believe can best meet your affordability, suitability and investment goals. Please be aware that you must read and understand each CTA's disclosure document carefully before investing. Trading futures and options involves substantial risk of loss no matter who is managing your money. Such investments are not suitable for everyone. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

This piece has been prepared by Vision Financial Markets LLC, a registered Futures Commission Merchant. Futures traders should be aware that daily market volatility might cause loss despite prevailing trends in the stock market. The risks associated with trading futures and options are significantly different than those of stock investing and investors may lose more than their initial investment. While we advocate diversification, please be advised that it will not necessarily provide protection against substantial loss. Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

Caroline Madden, "Rebound in commodity prices set to continue", www.irishtimes.com, 31December 2010 (1, 4, 7, 12)

Deborah Roy, "Commodities Spearhead Global Recovery," China Daily, 3 January 2011 pg 1 (2,5)

Barton Biggs, Fire and Ice, 10 October 2010 (6, 10)

Liam Pleven and Carolyn Cui, "Commodities Rally Across Board", The Wall Street Journal, 3 January 2011 (3, 15)

Egon von Greyerz, "Hyperinflation to drive gold price to $10000/oz", Gold Switzerland, 2 January 2011 (9)

"Investment Demand Will Continue to Support Robust Gold Market During 2010",
www.prnewswire.com, 25 August 2010 (8)

Robert Lenzner, "Here's How John Paulson Made $5 Billion Last Year", Forbes, 29 January 2011(11)

The Blackstone Group, "Byron Wien Announces The Ten Surprises for 2011", www.businesswire.com, 3 January 2011 (14)

Liz Skinner, "2011's hot commodities: Corn, metals, oil", Investment News, 2 January 2011 (16)

"Gold Well Below Inflation Adjusted 1980 High in Deutsche Mark", www.goldseek.com, 25
November 2010 (13)

Barry Grey, "Commodity Price Surge Sets Stage For Global Food Crisis in New Year",
www.islampolicy.com, 1 January 2011 (17)

John Mauldin, Forecast 2011: Better than Muddle Through, www.investorsinsight.com, 8 January 2011 (18, 19)

Howard Gold, Ten surefire predictions for 2011, www.marketwatch.com, 7 January 2011 (20)

Jayant Manglik, Commodities to Ramin Best Investment Option in 2011, The Financial Express, 3 January 2011 (21)

Paul Justice, A Commodities ETF with a Hedge-Fund Strategy, www.moneyshow.com, 28 April 2010 (22)

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