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7/14/04
Inflation Plays:

We received the following query from a thoughtful and hopeful Mr. R.:

It seems as if commodities have continued doing extremely well. Do you still think that stocks will outperform them the next decade? I sure think stocks will get pounced by commodities, at least through 2010 or so… Commodities and stocks have seemed to run in 20-year trends historically, is history changing?

Victor Niederhoffer replies:

I believe that the average stock has gone up considerably more than any inflation index since I wrote you. And that this differential relative to any funds based thereon will continue. I refer you again to Julian Simons' work and the Triumph of the Optimists by Dimson et al.

Dr. Castaldo Responds:

1. Commodity prices are cyclical, as your CRB chart shows: up/down/up over say 3 to 5 years. There is little evidence of a long term trend.
2. During the Up phase of the cycle ordinary investors rush to invest in commodity vehicles, of which Pimco Commodity Real Return is an example. This fund has been in existence only since March 2003, far too short a time to assess its record. Its long term performance is likely to bear little relationship to its performance since inception, which however is good enough to attract customers. Customers who, if past cycles are any indication, are likely to be disappointed 2 or 3 years from now. In addition its Expense Ratio of 2% seems high to me for a large fund with a very simple investment policy.
3. I would emphasize that stocks are preferable to commodities OVER THE LONG TERM, but anything can happen over a year or two.
4. Just for fun here is a description of Julian Simon's famous bet on metal prices:

Julian Simon's Bet With Paul Ehrlich

In 1980, economist Julian Simon and biologist Paul Ehrlich decided to put their money where their predictions were. Ehrlich had been predicting massive shortages in various natural resources for decades, while Simon claimed natural resources were infinite.

Simon offered Ehrlich a bet centered on the market price of metals. Ehrlich would pick a quantity of any five metals he liked worth $1,000 in 1980. If the 1990 price of the metals, after adjusting for inflation, was more than $1,000 (i.e. the metals became more scarce), Ehrlich would win. If, however, the value of the metals after inflation was less than $1,000 (i.e. the metals became less scare), Simon would win. The loser would mail the winner a check for the change in price.

Ehrlich agreed to the bet, and chose copper, chrome, nickel, tin and tungsten.

By 1990, all five metal were below their inflation-adjusted price level in 1980. Ehrlich lost the bet and sent Simon a check for $576.07. Prices of the metals chosen by Ehrlich fell so much that Simon would have won the bet even if the prices hadn't been adjusted for inflation. Here's how each of the metals performed from 1980-1990.
(Prices expressed in 1980 dollars)