The Hunt for Stocks

With the leading indexes of the US stock market heading to one of the worst Junes since The Great Depression, it’s getting harder to bird-dog for stocks that won’t just come apart but will actually do something for us.

The usual suspects of the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite are doing little more than vacuuming value from too many investors. But two markets are still racking up gains--and even paying us along the way.

You won’t find them if you’re looking for stocks, only if you’re hunting for commodities and bonds.

This is one of the oddest combinations of performing investment groups. Usually when commodity prices are running, bonds tend to be shunned. But not all bonds are alike; they don’t trade in lock-step, either up or down.

The same should be noted for commodities. Contrary to popular opinion, not all commodities are running at an increasing pace; some are actually falling in price.

Even in the better market segments, you can’t simply use the shotgun approach--unless you’re dog has done his job flushing out the fowl.

Bonds Aren’t Busted

Let’s look at the bond side first.

Inflation is the cancer of bond portfolios, so we need to figure out how and why some bonds and funds will work against the loss of our principal. And we still want to get paid the right amount of interest to trump rising costs of living.

We all need cash coming in from our portfolios, and this is what bonds add to the right investment mix. Amid mounting evidence of rising inflation, we need a whole lot more cash coming in.

Whether at the grocer or the corner petrol station, during the past few months the costs running a household have gotten way out of whack. The situation isn’t likely to get better anytime soon.

Commodities prices have soared during the last 12 months.

But the official inflation numbers don’t look that bad. The Consumer Price Index (CPI) is running in the mid-2 percent range. And though it’s climbing, it seems, on paper at least, that we don’t really have an inflation issue.

Core inflation, of course, factors out the shorter-term swings in food and fuel prices--the exact two groups of raw goods that are soaring in price and stinging our wallets.

If we take into consideration the food and the fuel, the headline rate is running at 4 percent-plus. That’s nowhere close to how costs for our household budgets are advancing for the year.

Despite slower growth in the US domestic economy--we expanded at a rate of only 1 percent last quarter--wage gains are still ramping up, with the US employment cost index running at more than 3 percent. But that’s a broader average. If you look at the labor data published the first Friday of every month, you can drill through the databanks to find some truly disturbing bits of data.

In the private, non-government part of the work force, wages advanced for the most recent month at an annual 8.3 percent. That’s right: Not only do we have real goods ramping up in cost, but we’re also getting whacked in labor costs to process, deliver and serve us along the way.

Rather than hoping the Federal Reserve will do something to control inflation, we should spend our time fleshing out the right investments. Perhaps we should look to bonds that are generating enough revenues and gains to help us keep up with the rising cost of living. And maybe we can get a tick or two ahead.

Most folks tar bonds as sure losers during inflationary times. But the bond market is comprised of many, many issues, a wide variety that don’t look, act or perform in the same manner.

The US Treasury yield curve shows that T-bills are running at under 2 percent, and we don’t start to see above-inflation yields until we head out closer to the five-year end of the curve. And to beat headline inflation, we have to go way, way out to 30 years. Even there, it depends on whether you’re bogey is core, headline or some other measure of inflation.

Whatever the timeframe, it’s difficult to see holding ground against inflation. It sure won’t be easy for such bonds to counter the real world of rising costs for so many of our household goods and services.

We have to look to two areas of the bond market to generate sufficient yield and to find genuine opportunities for gains to not counter not just reported inflation but the real world variety as well.

Step by Step

The first step in the long, inflation-fighting journey is to focus on non-US dollar, non-US bonds. This is where we can counter the impact of a cheaper dollar and the resulting run up in real goods’ prices. If we can grab more European, Asian and even some Latin American bonds that are in markets and currencies beating up on the dollar, we can have one of our hedges against real world inflation.

If you’ve been reading Personal Finance and The Yield Letter, you know I’ve filled the respective portfolios with solid recommendations, including AllianceBernstein Global High Income (NYSE: AWF), BlackRock Income Opportunity (NYSE: BNA), PIMCO Strategic Global Government (NYSE: RCS), Templeton Emerging Markets (NYSE: TEI) and Western Assets Emerging Markets (NYSE: EFL).

Each of these closed-end funds has been selected not just for their management and not just for their higher yields, but because the performance of the non-US bonds.

The second step is to consider our growing collection of quality, high-paying corporate bonds I’ve been writing about in PF and The Yield Letter, what I refer to as “mini-bonds.”

Yields on the mini-bonds I’m focusing on range from the mid- to upper-6 percent area to as high as 7, 8 or 9 percent. You’ll also note that mini-bonds, which trade in the stock market like preferred shares, are priced and trade around $20 to $25 each. The list is longer than our fund roster, but even the smallest investor can buy a wide collection of these inflation-beating, generous-yielding mini-bonds.

Don’t cherry pick; buy an assortment. Not only will you have a well-timed series of dividend/interest payments throughout the year, but you’ll have a lot more principal protection from the daily and weekly price swings.

For example, take a look at the old Baby Bell out West, Qwest Corp (NYSE: Q). Qwest 7.75 Percent Note of 02/15/31 (NYSE: PKH) is trading around 23 for a current yield of 8.4 percent. The mini-bond is backed by Qwest’s solid asset base, which includes hefty landline, data and wireless operations in markets.

Because they trade like stocks, the volatility may be daunting for the novice, especially if you’re trying to buy bonds not just for the hedge against the crummy stock market but for stable performance.

But a look at the longer term (and we mean over months in this context), you’ll see prices and trading level out. If we buy, hold and build up our mini-bond collection, we may have a month or two of wide price gyrations, but over time they’ll level off. And on down days and weeks, we can pick up some really nice deals.

Raw Deals

But bonds aren’t enough. And thankfully, another side of the market is also providing real oomph even as the broader stock market suffers: raw goods.

Many of you may immediately go for energy or metals, but one of the best areas of the commodity markets to cash in is the agriculture segment.

Take a look at one of your recent grocery bills. It’s probably scary, just like your most recent receipt from the petrol pump. And rising food costs are impacting not just the US but families all over the developed and developing world as well.

Earlier this month delegates from all over the world gathered in Rome for a United Nations-sponsored summit to discuss supply, demand and how to rein in prices.

During the past five years, consumer food costs have soared by more than 117 percent, or nearly 18 percent on an average annual basis. And that momentum is increasing; in the trailing 12 months alone, prices surged more than 52 percent.

But rather than seeking blame, as politicos like to do, we can look for the opportunities in this state of affairs.

This is exactly what the heavy-money guys have been doing for the past few years: Major private-equity investment funds, such as Texas Pacific Group (TPG), and pension funds have been buying agricultural goods--corn, wheat, beans, coffee and just about anything else that feeds our families.

This has been evidenced by the surge in investment appetites for futures contracts at the traditional commodity exchanges in Chicago and London. The markets have also moved beyond traditional futures to structuring buy-and-own investment securities.

These enable investors to both hedge against rising costs as well as simply make money off rising prices. And the fruits of their labors show up in the likes of a Deutsche Bank index that tracks the agriculture market.

This index has stomped the general stock and bond markets over the past year, with gains so far this past year exceeding 47 percent, rivaling energy in overall return.

This is now hitting enough consumers--who are also voters--that politicians, already trash-talking new taxes on petrol companies, are now focusing more attention on the agricultural side of the commodity markets.

And now the Commodities Futures Trading Commission (CFTC), the junior regulatory sibling to the Securities and Exchange Commission, is floating the idea that it will restrict how much investors outside the food industry can own in the commodity markets.

And the CFTC is finding friends on Capitol Hill who are threatening to bring forth legislation to back up such potential restrictions.

But we still have a free market in the US, and in other nations around the world, which means the market for food commodities is global. Although Chicago and New York may think they can control who trades what, markets beyond our borders, from London to Shanghai, will simply pick up the slack.

The mega-investors aren’t waiting around; they're buying into other parts of the ag business--from grain elevators to ag processors and distributors--as a workaround for such potential regulation.

You shouldn’t be sitting on your hands, either. This food trend is going to be here for a while, so you better stake your claim while buyers still outnumber sellers.

For several years now, I’ve written about and recommended several agriculture-focused companies in Personal Finance, getting a jump on the story before the price of crops soared enough to grab international headlines.

In the past, I’ve told you to buy and cash in and out of several ag giants, such as Archer Daniels Midland (NYSE: ADM) and Monsanto (NYSE: MON). Such recommendations provided double- and sometimes triple-digit gains.

But you can't just throw money at this sector--even if it appears to be on autopilot to the moon. You need to know which companies and funds are going to continue to cash in and which ones may well become compost.

First, not all food commodities are rallying. A deeper look at the commodities market reveals big disparities. Livestock is barely registering gains, and other ag products have even gone negative to the consternation of some hapless investors.

Second, even in the ag markets that are running up, you need to buy the companies that can price products rather than just take the higher prices.

Companies that supply the goods and services to grow the pricier products rather than supply goods to consumers are better positioned to take advantage of rising commodities prices. Take a look at fatalities such as Smithfield Foods (NYSE: SFD), which saw its last quarter’s profit wiped away from rising feed grain prices, or ConAgra Foods (NYSE: CAG), which absorbed the higher raw food costs but has had trouble passing them on.

Real Goods Investing

To get a solid base for your own portfolio, start with two index funds structured around the Deutsche Bank commodity indexes. The first is the broad Deutsche Bank Commodity Index Tracking Fund (AMEX: DBC), which owns all the underlying commodities, from ag to metals to energy, and provides full participation in rising commodity prices.

Second is one of the subsets of the broad commodity index that’s focused on the food segment. Deutsche Bank Agricultural Fund (AMEX: DBA) owns and tracks corn, wheat, beans and sugar, which comprise the core of the food market.

Combo Plays

What about rolling bonds and commodities into an easily tradable package?

That would leave us with what are called exchange traded notes (ETN), which I’ve recently discussed in The Yield Letter.  

ETNs are notes or bonds that are issued in the public market and trade on the major stock exchanges. Typically, ETNs are denominated in sums under a $100 dollars. These bonds are indexed to specific commodity indexes as well as other assets.

The majority of ETNs are issued with longer-dated maturities, which range up to 30 years. But although such a long time period might discourage some investors, note that they can be traded on a daily basis and there’s an additional level of protection.  

On any given trading day, holders of most ETNs sell them back to the issuer. Consequently, you don’t have to worry that market issues will prevent you from trading them, nor do have to worry about a widening in the bid/offer spread or the market’s view of any particular issuer or index-link.

If you want out, give the bonds back to the issuer for the current value of the bonds.

And ETNs offer additional advantages. First, each ETN’s value is based on a particular index; in other words, the holder’s return is linked tick-by-tick to the underlying value less the annualized management fee charged by the bond’s issuer.

This means that once you familiarize with the index and its composition, there should be little deviation between the value of the bonds and the performance of the underlying index. The only potential issue is in the indexes chosen for each particular bond.

Second, each of these bonds does not pay current interest; for most of these bonds there is no current ordinary income in terms of tax liability. Only when the bonds are sold in the market or put back to the issuer is there any tax liability, which is qualified as capital gains as opposed to ordinary income.

There are some exceptions, but all the commodity index-linked ETN bonds in the market currently offer these benefits.

Issuing bonds linked to indexes or other assets is not new. Institutions have been doing this for pretty much the history of the bond market. What makes these interesting is that, like our mini-bonds, they’re engineered and built for the individual investor and trade in manageable denominations.

An ETN I’ve recently highlighted in The Yield Letter cashes in on the grains part of the agriculture market. The Barclay’s Bank-issued AIG Agricultural Total Return Sub-Index ETN (NYSE: JJA) is one way cash in on or hedge against further rises in grains, beans and sugar prices.

Cash In

Now that we’ve identified what’s worth your investment cash, how about spending some time with me on a great boat discussing the markets, individual stocks and anything else that comes up?

Here’s the latest on the 2008 KCI Investing Cruise, which will depart from Miami, sail the Caribbean (including one of my favorite islands, Saint Barthelemy) and continue through one of the world’s engineering marvels, the Panama Canal, before reaching Costa Rica. 

Click here for more information.

Dead Guys of the Week

It wouldn’t take long to flush out this bird. He stands more than six feet tall and is sun-yellow.

Big Bird’s been a staple for kids on Public Broadcasting Service (PBS) stations nationwide for decades, and although the man inside Bid Bird, Caroll Spinney, may be more famous, the man truly responsible for the icon is dead at 91.

Kermit Love designed Big Bird’s and many other characters’ (including my favorite, Mr. Snuffalufagus) for the Muppets and other production groups.

One dog that could find nearly anything--be it fowl or man--died last week at a mere six years old.

 Charger was a police bloodhound for Fairfax County in the Commonwealth of Virginia. Charger, who loved his ever-present red ball and a particular brand of multi-flavored Alpo treats, helped track and capture numerous criminals during his exalted career.

He died of cancer of the leg and, like other dogs beloved by their families and companions, including my mother’s dog, Mini, who also passed due to cancer, Charger will be missed and mourned.

Speaking Engagements

“The coldest winter I ever spent was a summer in San Francisco,” a saying that’s almost a San Francisco cliche, turns out to be an invention of unknown origin, the coolest thing Mark Twain never said.

The natural setting is, however, among the most exciting in the US. Venture west for the San Francisco Money Show Aug. 7-10, 2008, and conduct your own field study.

Roger Conrad, Elliott Gue and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.

Click here or call 800-970-4355 and refer to priority code 011363 to attend as our guest.

I’ll also be appearing at the following events:

• The Financial Advisors Investment Conference, October 2008
• The Washington Money Show, November, 2008
• The World Money Show, London, England, November 2008
• The 2008 KCI Investing Cruise, Dec. 1-12, 2008

If you’re interested in having me or one of my cohorts address any investment or professional groups, please e-mail me at paymeweekly@kci-com.com with ideas or suggestions.