Betashares Offers Commodity ETFs for Australians

Link: BetaShares

Most people invest in shares, bonds, and real estate. Shares and real estate tend to perform well during an economic boom. Government bonds are seen as safe investments since they are backed by government, and many people hold government bonds or government bond funds in addition to growth assets such as shares and real estate in order to diversify. But what about commodities?

The word "commodity" is not perfectly clear, but investing in commodities involves investing in such things as gold, oil, soybeans, wheat, and livestock. It is an investment in hard assets that are more often than not necessary for humankind. Investment in commodities are perfect not really for periods of economic booms or economic recessions. Rather, commodities are excellent to hold during times of stagflation, that is, a combination of stagnant economic growth and inflation.

One way of combating massive inflation is to adopt The Alpha Strategy, that is, hoarding essentials such as rice and toilet paper in your home. The less extreme option is to buy a commodity ETF.

For Australians, a firm called Betashares provides a diverse range of ETFs, including an ETF that invests in crude oil futures. I am thinking of using my margin loan to purchase a good chunk of commodity ETFs via Betashares but I am unsure if I should. Perhaps shares in resource companies already provide sufficient commodity exposure. The fact the Australian dollar is a commodity currency also provides some exposure. Then there is the worry about the safety of synthetic ETFs (read Quant Congress USA: Avoid synthetic ETFs, says Avellaneda - Risk.net) with some saying they are fine for short-term trading but not appropriate for long-term investing due to counterparty risk.

If anyone has any deep knowledge on this issue, please comment.

The Alpha Strategy

I have just finished reading The Alpha Strategy, which is a book that I simply downloaded off the internet (see the link earlier) and put onto my mobile phone using a free software called EBookMe. In other words, I paid nothing to read this book. I think there is no need to pay money to buy a book because ebook programs like EBookMe are free and there are virtually infinite free books out there on the internet that you can easily find.

The Alpha Strategy is a good book. It is about the problem of inflation and what individuals can do to protect themselves from inflation. This books pretty much claims that a good way to protect wealth from inflation is to stock up on goods, e.g. toilet paper, wine, honey, and so forth. The ideal is that you stock up on goods that you will need anyway so that it won't matter if the price of these goods go up. If this is not possible e.g. because it is difficult to store wine, etc, then the next best move is to stock up on raw commodities like copper. There is a whole section near the end of this book that explains how to buy copper from the futures market. This book was probably written during a time when there was no exchange traded commodities (ETCs) for sale.

I think stockpiling goods is a great idea, but the main problem is that a lot of what the author is explaining is just too difficult. It is very unrealistic for me to start stockpiling because I still live with my parents. If I were to start piling up toilet paper in my bedroom, my parents would not be happy. Because most goods deteriorate (e.g. wine may go off if exposed to too much light) then you have to be very careful about the storage conditions and you have to make sure everything is stored securely because of the threat of theft. It is all very difficult. While reading the book I got the feeling that this investment strategy of the author was just an excuse he was using to justify his love of shopping, e.g. he describes in detail different types of wine.

I think the author's stockpiling strategy is good and I definitely will think about using it, but I won't put all my wealth in stockpiled goods. I think putting, say, 10 per cent of your wealth in stockpiled goods is a good idea, e.g. I might stock up on some soap or some breath mints or tic tacs.

Is the Resource Super Profits Tax Unfair?

After the GFC, the Australian Labor Party led by Kevin Rudd stimulated the economy by splashing cash. As a result, the Australian government created debt that needed to be paid off. The opposition Liberal Party criticized Labor for its reckless spending, but in this year's Commonwealth Budget the government announced it plans to be back in surplus soon thanks to a tax on the reosurces sector called the resource super profits tax (RSPT). Any mining projects in Australia will be taxed at 40 per cent above the 10-year bond rate.

The proceeds of this mining tax will be used to fund a reduction in the company tax rate from 30 per cent to 28 per cent. It will also be used to fund a range of other expenditure items, including benefits to small businesses.

Even though companies will get a reduction in company tax rate, the reduction from 30 to 28 per cent is miniscule. Furthermore, companies will be faced with the increased burden of a higher rate of superannuation it has to pay to workers (from 9 per cent to 12 per cent). The government is currently trying to buy favor among miners by giving them a infrastructure fund that will be used for spending on mining exploration and the like. This is horrible! Why would you take money from someone with taxes and then give that money back? Even if you take $100 from someone and then give that person $100 back, this creates a net loss for the economy because of administration burden plus other inefficiencies.

I am all for fair tax, but this strikes me as unfair. Based on what I have learned in university, the best kind of taxation is one that is difficult to avoid and is broad-based. A tax like the goods and services tax (GST) is an example of a good tax because just about everyone pays it when they purchase a product (ignoring, of course, the exemptions in current GST law on certain food). A flat income tax is good. Land tax is also excellent. A poll tax is probably the best kind of tax, although historically poll taxes are very unpopular.

However, the RSPT is not broad. Rather, it is very narrowly focused on the mining sector. The mining sector is hit by this massive tax on super profits while banks do not pay a super profit tax. The Labor government argues that these non-renewable resources belong to the people and hence the people must get their fair share back. This is all well and good, but if the principle of taxation is to tax those that use natural resources, why aren't farmers slugged with a super profits tax for their exploitation of the land? Why aren't home owners slugged with taxes for using their land they live on? Rather we see massive tax exemptions given to home owners and farmers.

The RSPT is also very worrying in that it creates an atmosphere of uncertainty. If the Australian government can just implement massive taxes on a whim, who is to say the mining sector will be the only victim? You may not think the mining tax affects you maybe because you are heavily invested in banking shares rather than mining shares. But given that Rudd has shown that he is willing to slug a massive tax on anyone who is successful, who is to say he won't start applying a tax on banks next? If a gunman enters a room and shoots the person right next to you, you would be scared because this gunman is clearly has murderous intend and just as he has shot and killed your friend he could easily shoot you. Likewise, Kevin Rudd is a like a gunman, shooting sectors of the economy with taxes. You may be lucky now but who is say that in the future he might not slug a tax on you or your investments? Think you can run away from the tax by putting your money into gold? He might put a tax on that. He might do anything. The extreme would be some kind of tax on men because they earn more than women. The idea of a man tax has actually been suggested by some people.

I am not anti-tax. I think tax is essentially because government needs money to provide essentials to the public. But why can't the government just reform the tax system by levying a simple and fair land tax or a simple and fair income tax? These various exemptions and deductions that exist in current taxation legislation do nothing but divide citizens.

Global Mining Investments Ltd Yields 13.2%

I was browsing through Commsec and realized that the listed investment company Global Mining Investments Limited (ASX:GMI) has a dividend yield of 13.2 per cent. This seems incredibly high and makes me wonder whether mining and energy stocks are good value now that commodity prices are down. If emerging economies like China and India pick up again in the future, we will certainly see demand for raw materials needed to build infrastructure.

Good value in GMI relies on dividends remaining high. In the current environment, that is not certain. Maybe within the next few months we will see many companies starting to lower their dividends.

Using Precious Metals to Protect Against Rising Food Prices

Now that we are in a new year, the world is going through what looks like a deflationary recession. Deflation is feared by economists because there is little they can do about it. If we have inflation, the central bank can raise interest rates or increase taxes. When there is deflation, central banks can lower interest rates, but once interest rates hit zero, it can't go any further.

Now that everyone is worried about deflation (and some people worried about future hyperinflation), I am still worried about stagflation, which is a combination of economic stagnation and inflation. This means that you are likely to lose your job, the share market performs poorly, and to make life difficult, the price of everything goes up.

Personally, if the price of luxury cars go up, I am not bothers because I don't buy luxury cars. But if the price of necessities like food and petrol go up, that is going to hurt.

The chart below compares for the last two years the price of oil (measured using USO, the oil commodity ETF), the price of food (measured using DBA, an ETF that tracks the prices of wheat, soybeans, corn, and sugar), as well as the S&P500 index (GSPC). To measure the performance of the real economy, I should probably be using GDP figures, but using the S&P500 I think is good enough.


At about May 2007 what we see is a divergence between the S&P500 and the price of oil and food. Oil and food go up while the S&P500 stagnates. This is stagflation. Just about everyone was complaining about expensive food and oil. Many were talking about peak oil.

Then at about October 2008, we had a violent transition from stagflation to deflation. As the chart shows, everything went down. The share markets tanked, food prices fell, and oil prices especially plummeted from about US$160 to around US$35.

How can we protect ourselves from stagflation? One method suggested is to buy precious metals like gold and silver. Below is a chart of oil and food prices against prices of gold (measured using GLD, the gold ETF) and the price of silver (measured using SLV, the silver ETF).


What we see, interestingly, is that silver and gold would have protected us very well during the stagflation era of 2007-08. The price of silver and gold seems to move together with the price of food. The price of oil went even higher than the price of food, silver, and gold, but I believe oil was way overvalued and because oil went up so high, a hard fall was inevitable.

What is also interesting is that during the transition from stagflation to deflation, silver prices went down with food prices. However, gold prices seem to have held up. Gold investors don't seem to have realized that stagflation is over now.

Could gold be overvalued? Perhaps it's time to short gold.

Markets Fall After Bailout Rejected

Tomorrow I will have to report on my net worth and I am not looking forward to it. In the US, the bailout has been rejected and world markets have crashed. Here in Australia the All Ords has fallen about 3 per cent to 4500. Some people who are geared into the stock market, such as Enough Wealth, don't seem to be posting anything. They have become very quiet.

Last week I purchased 20 shares in Woodside Petroleum, hoping the bailout would be passed, economic growth would resume, and oil and gas prices would go up. I purchased each share at $57. Today each share is $52. When I purchased the shares, the price of oil was US$106 per barrel. Now it is US$96 per barrel. I'm not complaining because I rely on petrol a lot since I drive about 50 kilometers every weekday. I think it's important that I hedge myself against rises in petrol prices. If this downturn continues and oil prices remain low, I should be able to pick up cheap shares in oil companies to prepare myself for what might be an oil boom in the future.

Investing in Oil Companies

With the recent collapse of Lehman Brothers, shock waves have hit the world markets. The All Ords is at 4700, which is very low. The price of oil has gone down from US$147 per barrel to US$90 per barrel. The price of petrol here in Australia is still high because the Australian dollar has depreciated. One Australian dollar used to buy US$0.98. Now it buys only US$0.80. I am happy that my mutual fund invests about 40 per cent in non-Australian assets because that will definitely boost my returns as the Australian dollar depreciates. I have always said that a home country bias is stupid, and now this currency depreciation proves it.

If I am going to buy shares in a company, I am thinking of buying an oil company. The reason why is because oil seems rather cheap at the moment, which would have depressed the stock prices of oil companies. Another reason is because it can provide me with a hedge against rising petrol prices. Petrol prices are by far my biggest expense. Jack at The Survival Podcast believes that this reduction in the price of oil is temporary and oil will keep going up. Many people who believe in the dominance of China and India believe that oil will continue to go up in the future. The real question then is whether supply can keep up with what is expected to be rising demand. The supply of oil is highly manipulated by cartels like OPEC. In general, suppliers of oil are criminals who control countries. They sell oil to us as if they are drug dealers taking advantage of our addiction. Many say that we are near Peak Oil and that oil producers are lying to us about how much oil they hold. I am scared about the opposite, which is Deep Oil. I am worried that there is plenty of oil in the world but the suppliers are hiding it so that they can extract as much money from us as possible. The Peak Oil versus Deep Oil controversy is far too complicated for me at the moment. Most of the articles on the Internet delve into conspiracy theories.

Australian Energy Companies Boom As Oil Rises

Last Thursday on 10 July 2008 I invested $703 when the All Ords was 5000. Today, Wednesday 16 July 2008, the All Ords has fallen to 4815. The market seems to be going down and down.

A closer look reveals that the problem comes mainly from financials and banks such as the Commonwealth Bank and NAB. Investors may be spooked by problems in America with Fannie May and Freddie Mac.

Energy companies listed on the ASX however seem to be fine. Based on my records, I have done 14,956 kilometers of driving since 17 February 2007. Since today is 15 July 2008 then that means that I drive on average about 10,000 kilometers per year. Since I have driven my car 14,956 kilometers and since my car's fuel economy is 11 liters per 100 kilometers, then it means I've used 1645 liters of petrol so far. Based on my records, petrol during 17 February 2008 cost $1.14 per liter and now on 15 July 2008 costs $1.61 per liter. That is a 41.22% increase. Because petrol has increased by this much, I have spent $773 extra on petrol. This means that if petrol prices continue to go up by this same amount and I do the same amount of driving as I have already done, I will pay an extra $500 per year. That is actually not that much. That is approximately how much is costs to sponsor a child from World Vision for one year.

Here is the the interesting thing. Since 17 February last year petrol has gone up by 41.22% but the stock price of Woodside Petroleum has gone up by 66.9%, the stock price of Oil Search has gone up by 57.7%, and the stock price if Santos has gone up by 86.4% These are all Australian energy companies. It seems as if these energy companies are doing very well under conditions of high petrol and oil prices.

So then what if I buy shares in energy companies as a hedge against fuel inflation? If I assume that share prices move exactly like petrol prices (which is unrealistic) then how much will I need to hold to fully hedge against any rise in petrol? After some number crunching, the answer is $1154. Not much. If I buy $1154 worth of shares in energy companies and if these energy companies' shares go up by the same amount as petrol prices, then I will be fully hedged. If petrol prices rise, I lose more at the pump but I am compensated by capital gains. If petrol prices drop, I make a capital loss but I am compensated by lower fuel expenditure.

Any Australian can buy shares from the ASX by signing up for Commsec. It just so happens that I have about $22,000 invested in a mutual fund. This mutual fund invests about 44% in Australian shares. That means $9680 is invested in Australian shares. Since this is an index fund, it tracks the ASX300 index. I know for a fact that 9% of the ASX300 is made up of energy companies. This means that I have already $871.20 in Australian energy companies. Therefore, I may already have a partial hedge.

Using Index Funds to Hedge Against Rising Petrol Prices

The rising price of petrol is making news here in Australia where petrol is reaching unprecedented highs of $1.60 per liter. I drive to work and to the train station to go to university. I also drive my grandma around sometimes. I fill up approximately every fortnight. I pay approximately $70 each time I fill up. Since my parents fully subsidize my food and accommodation costs, just about all my spare money goes to petrol. It is by far my biggest expense. Crude oil futures on the New York Mercantile Exchange is about $130 per barrel now.

If I lived in the United States it would be easy for me to buy oil ETFs (AMEX:USO) that would go up in value as oil goes up in value. It'd be as if I'm buying barrels of oil on the stock exchange. But alas I live in Australia so access to American investments are complex and costly. Investing in American crude oil is not a perfect hedge against rising petrol prices in Australia because crude oil and refined petrol are different products. Exchange rates between the Australian dollar and US dollar would also add another layer of complexity.

How then can I hedge against the rising costs of petrol? One of my friends jokingly told me to buy a bike. With the distances I have to travel this is just not practical. Plus I'm scared of loud trucks. Hopefully with higher petrol prices these loud trucks will go out of business.

Another idea is to invest in the resources, energy, or materials sector. One of the best performing and one of the most popular managed funds in Australia today is the Colonial First State Global Resources Fund. In the past year it has given investors a return of 27 per cent. In the past five years the average annual return is 30 per cent. Looking at this fund's top ten holdings, I notice that there are many familiar Australian faces like Rio Tinto, BHP Billiton, Xstrata, and Lihir Gold. There are also some Canadian companies in there like the Potash Corporation and Nexen. Instead of investing in the high-cost actively managed CFS Global Resources Fund, why not invest in an index fund that tracks the top Australian companies? This may work since Australia's top companies are heavily biased towards the resources and financial sectors. The financial sector is the largest sector in the MSCI Australia Index, making up approximately 40 per cent of the index. However, together the energy and materials sector make up 35 per cent of the index, which is quite a lot. Simply by investing in, say, the Vanguard Index Australian Shares Fund or the SPDR ASX200 ETF, you can probably get good exposure to Australian companies that deal with commodities.

Why just look at Australia? The MSCI Emerging Markets Index is very heavy with commodity companies, many of which are state-owned. The energy sector makes up 17.04 per cent of the MSCI EM Index while the materials sector makes up 12.99 per cent of the index. The energy sector and materials sector make up 11.39 per cent and 8 per cent of the MSCI World Index respectively, which is relatively low. This suggests that if you want exposure to resources companies, go to the emerging countries and Australia.

It is not that simple. Just because you invest in companies that deal with commodities, it doesn't mean you've hedged yourself against rising commodity prices. The cost of mining and transport might be higher, which may affect profitability. Even though commodity prices go up you may simply be investing in a bad company with bad managers and bad workers. Furthermore, many of these resource companies may specialize in gold, silver, and materials like iron ore. These may have little if not anything to do with oil or petroleum.

Food Prices Rise

See World's New Crisis: Soaring Food Prices.

With food riots around the world today, many are making Malthusian predications about the world. One of Malthus's predictions is that more wealth would result in higher fertility rates because of lack of moral constraint, and so this would lead to mass starvation since people grow at a faster rate than food. Malthus turned out to be completely wrong. What we see today is that fertility is highest in poor countries while rich people tend to have fewer babies.

Producing children in chaotic, poor countries is a form of insurance since children can be used for labor on farms and also children may help the parents when they are older, making them akin to a pension.

This is why in Australia fertility rate is so low. Producing children has no actuarial benefit. Rather, children are only produced for pleasure. The problem is that children compete with other luxury goods for pleasure, such as Ferraris and holidays, which further reduce levels of fertility.

Some Australians I have spoken to say that the problem of food scarcity may make Africans desperate to escape to developed countries like Australia. They advocate then a wall around the country.

If Africans are breeding too much and Australians are breeding too little and if there is a scarcity of both skilled and unskilled labor in Australia then economic theory suggests the best idea is to allow free flow of labor between Australia and Africa. Unskilled Africans can work picking fruits on Australian farms. This will increase food production as well.

Putting a wall up separating free flow of labor is a form of Communism since you are not letting the free market allocate labor inputs to its most productive use but rather you are using central planning.