How To Make A Small Fortune In Commodities
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. My History With The Commodity Futures Markets
2. How To Make A Small Fortune? Start With A Large One
3. Why The Commodity Futures Markets Are So Risky
4. Why Almost All Individual Investors Lose Money
5. How Investors Go Wrong – Let Me Count The Ways
6. Only Invest With Professional Trading Advisors
The commodity futures markets have increasingly become more active and more volatile over the last year or so, and especially in the last few weeks. With stocks looking increasingly risky, and with the slump in the real estate markets, investors have been searching for other places to find returns, including so-called “alternative investments” such as hedge funds and commodity funds.
Historically, the performance of professional futures Trading Advisors, and the futures markets generally, have had a very low correlation to the movements and price trends in the traditional stock and bond markets. Thus, carefully selected investments in the futures markets can provide additional diversification to investor portfolios.
For these and other reasons, big money continues to roll into the commodity futures markets, hoping to cash in on some big trends. For the commodity brokerage community, it is yet another windfall, which they are celebrating (read: increased commissions). Yet let us not forget the facts when it comes to investing in commodities.
Based on my 30+ years of experience in the industry, I believe that the vast majority of individual investors who try to trade the commodity futures markets on their own lose money, often more than they originally invested. This week, I will give you the ‘low-down’ on investing in the commodities markets. For most of you, the answer is – just say no.
This is my advice based on over 30 years of continuous involvement with commodities and the futures markets. In this issue, we will briefly revisit that history, and I will offer you my best advice as to how you should proceed if you want to (or are being solicited to) invest in the commodities markets, as so many are recommending now. Here we go.
My History With The Commodity Markets
Immediately after receiving my Masters Degree in International Business in 1976, I was hired by Continental Grain Company, one of the largest international grain companies in the world. I started as a grain merchandiser in Ft. Worth, TX. On a daily basis, I dealt with grain elevator firms, feed processors, cattle feedlots, cotton gins and others in the agriculture industry. I bought and sold large quantities of wheat, corn, soybeans, grain sorghum and other commodities across a five state region.
After about a year, I transferred to the company’s commodity futures brokerage subsidiary in Dallas where I began a decade-long career of helping regional grain elevator firms, cattle feedlots, feed processors and others learn how to “hedge” their inventories from adverse price risk by using the futures markets. I quickly became the youngest Vice President in this international company.
In early 1978, I wrote my first book, “Hedging – Can You Afford Not To?” which is a manual for agricultural producers and agribusiness interests. It demystifies the complex process of using the futures markets to hedge risk and protect profit margins.
In the mid-1980s, in addition to my hedging business, I began to expand into helping investors who wanted to participate in the futures markets. In 1987, I launched a multi-Advisor futures fund that is still in operation today. In the years since then, I have started several other such funds that also continue to operate today.
So, with that little bit of background, let’s take a hard look at investing in commodities.
How To Make A Small Fortune!
There is an old saying that goes: The best way to make a small fortune in the commodity futures markets is to start with a large one. While this might sound amusing, it is very consistent with what I have seen over all these years when it comes to individual investors trading futures on their own. Thus, any discussion of investing in the futures markets should start with the following caveats: 1) futures trading is extremely risky; 2) you can lose more than you invest; and 3) on a percentage basis, I have seen very few individual investors who trade futures on their own make money – most lose money.
In the pages that follow, I will explain why most investors lose money in the futures markets. I’ll tell you why most of the products that are marketed to investors don’t work. Yet I will also tell you about the approaches to the futures markets that I believe offer the best chances for success. But first a little basic information about the futures markets.
Much More Than Commodities
When I first started in late 1975, the futures markets were largely made up of agricultural commodities (corn, wheat, soybeans, cotton, etc.), livestock (cattle, hogs, pork bellies, etc.), foods (coffee, cocoa, sugar, orange juice, etc.) and metals (gold, silver, copper, etc.). Futures markets in foreign currencies had just been introduced shortly before I got into the business.
Today, however, there are futures markets in just about anything you can imagine. In the early 1980s, we saw the introduction of so-called “financial futures.” A colleague of mine invented and introduced the Treasury bond futures contract at the Chicago Board of Trade. The T-bond futures market is the single largest market in the world today. Since then, we have seen new futures markets in just about every type of financial market: T-notes, T-bills, Fed funds, muni-bonds, CDs, etc., etc.
Likewise, we have seen new futures markets in dozens of US stock index contracts (Dow, S&P, Nasdaq, Russell, etc., etc.). There are also futures contracts in equity market indexes around the world.
Today, there are literally hundreds of futures markets in everything from the exotic to the mundane.
When I got into the business in 1975, futures were mainly traded only in Chicago, New York and London. Yet today there are thriving futures markets all across the world. Most of the successful professional money managers in futures trading are active in both the US futures markets and foreign markets – 24 hours a day.
Why The Futures Markets Are So Risky
The futures markets are highly leveraged, often as high as 20 or 30 to one. Let me use an example. A gold futures contract represents 100 ounces; at a price of $650 per ounce, that’s $65,000 worth of gold. Yet an investor can buy a gold futures contract with apprx. only $2,000 deposited as “margin.” If gold drops from $650 to $630, the investor loses $2,000. If gold drops to $620, he loses another $1,000. That’s $1,000 more than he originally invested, which he would have to meet in “margin calls” along the way, plus the commission when he finally gets out.
The fact that futures contracts are so highly leveraged means that these markets are inherently volatile. Wide and erratic price swings are commonplace. The smallest piece of news (or lack thereof) or even rumors can cause markets to swing wildly up or down or both, often within a single day.
The futures markets are not just impacted by the specific “supply and demand” factors for each commodity traded. While supply and demand factors are inherent in determining prices, many, many other factors influence these highly leveraged markets, such as: economic conditions, interest rates, inflation, geopolitics, news, public opinion and dozens of other factors which may, or may not, appear to be related.
Unlike stocks, bonds and certain other investment markets, the futures markets are a “zero-sum game.” What this means is that for every dollar that is gained, a dollar is lost. There are two parties to every futures contract. One party is “long” (meaning they bought) and will make money if the price goes up, and the other party is “short” (meaning they sold) and will make money if the price goes down. One side or the other has to lose, unless the price doesn’t change, and even then, both sides will pay a commission.
The participants in futures trading range from individual investors (called “speculators”) to investment funds (futures pools, funds and hedge funds) to the various floor traders and members of the futures exchanges. And of course, there are the “hedgers” that use the futures markets to protect the value of the commodities they own and/or deal in. When you go long or short in the futures market, you never know who is on the other side of the trade.
Most Individual Investors Lose Money
For the first seven years I was in the business, I worked almost exclusively with commercial agricultural firms who used the futures markets as a way to reduce the risk of adverse price fluctuations on their inventories of physical commodities. We were not in the markets to speculate; we were hedging to protect their profit margins.
I was the only “hedge broker” in our office. The other 8-10 brokers worked with investors who were trying to make money. During those years, it became obvious to me that most individual investors who traded futures on their own lost money, often a lot of money.
One year in the early ‘80s, the company had a big conference in Chicago. Hundreds of brokers from all around the country were in attendance, as was I. One of the company’s top executives announced that for the preceding year about one-third of the company’s speculative clients made money, about one third lost money and about one third broke even. He seemed to be proud of those numbers! I would later learn that if those numbers were true or even close to true, they may actually have been impressive. Here’s why.
At another conference a couple of years later, a small group of brokers and I sat and listened to a speaker who must remain unnamed. He had recently retired from one of the largest investment firms in the world. If I gave the firm’s name, everyone reading this would instantly recognize it. Anyway, this gentleman had been the president of the firm’s futures subsidiary for a decade. I’ll never forget what he told us.
He said that during his 10 years as president of the futures operation, apprx. 90% of individual investors who traded their own accounts LOST money. According to him, only about one-out-of-10 investors made money on average trading their own accounts in the futures markets. I was stunned, both at the numbers and that he admitted it!
How Investors Go Wrong – Let Me Count The Ways
Most investors don’t just wake up one morning and decide, “Gee, I think I want to try my hand in the futures markets.” No, most investors are solicited to open such accounts. They either get a phone call from a broker, or they see an ad in a newspaper or magazine, or they get something in the mail, or more recently, on the Internet.
In almost every case, the promoter or broker talks about (or writes about) the enormous potential for profit in the futures markets. Never mind the enormous risks I mentioned above. Never mind that the promoter or broker may have a long history of his clients losing money.
So the first way many investors go wrong is that they believe they can be successful, usually because they are encouraged to believe this by the promoter or broker.
As noted above, there are hundreds of variables that can affect the already highly leveraged and volatile futures markets. Most investors learn painfully that they cannot correctly predict which way the markets will go. They also learn that most brokers can’t either. At some point, most investors decide, I need a system to be successful.
Trading Systems, Books, Newsletters, Hotlines, Etc.
There are hundreds (maybe thousands) of so-called futures trading “systems” out there for sale. They come in all shapes and sizes and prices, but almost all of them have two things in common: 1) they promise the moon, some even guarantee profits (meaning they will refund the subscription price – not your losses – if they fail to deliver); and 2) they rarely ever work!
People often ask me about such systems, and I always have the same response: If it’s so successful, why would anyone want to sell it? I have seen cases where the promoters used systems until they didn’t work anymore, and only then did they decide to sell the systems to the public based on the earlier track record. My advice: Just say NO!
Likewise, there are dozens and dozens of books on the subject of futures trading. Some are actually quite good, some are mediocre and some are awful. But all are DATED material. More importantly, it’s one thing to read a book; it’s another to be able to actually do what they propose successfully. My experience is that most individual investors who trade on their own fail, even if they have read a book or two or try to follow a system they bought somewhere.
Ditto for newsletters and telephone hotlines that offer futures trading advice. I couldn’t guess how many newsletters, hotlines and similar services are out there today, especially on the Internet; suffice it to say there are hundreds. There are many inherent problems with trying to trade futures based on advice given in a newsletter, a hotline or even an Internet service. Even if the advice is generally good (which is rare), timing is a big problem.
My experience has been that for every one investor who has told me he was making consistent money following any of the services above, at least 10 told me they lost money and gave it up.
Most of the trading systems and services are very expensive. They hit you hard on the front end because they know you are unlikely to buy anything else or re-subscribe.
Don’t Do It On Your Own
My advice to anyone reading this who may be considering futures trading on your own is DON’T. The odds are heavily stacked against you! You can lose a lot of money – including more than you invest – very quickly.
In my experience, most of the advertised trading systems, newsletters, hotlines and Internet services don’t work either, at least for most investors. The futures markets are just too tough, too volatile, too complicated and too risky for investors to venture into on their own, in my opinion.
My advice as a 30-year veteran of the futures markets is, just don’t go there on your own, or with a broker, or with an advertised system, or with newsletter or hotline advice, and certainly not with some unproven Internet promotion.
Also, if you receive an unsolicited phone call from someone trying to sell you a trading system or trying to get you to open an individual futures trading account, consider this bad news. While illegal, there are “boiler room” type operations that will promise you anything to get you to buy what they’re selling.
But There Is Some Good News
There are, in my opinion, several ways to greatly increase your odds for success in the futures markets. If you have been reading me for long, you will not be surprised that in this arena, as with most others, I recommend that you use PROFESSIONALS if you decide to invest in futures.
Just as with stocks or bonds or other investments, there are registered professional futures Trading Advisors that can manage your money in the futures markets. If carefully selected, these professionals can significantly increase your odds for investing successfully in the futures markets. As usual, there are good futures Trading Advisors, and there are bad ones. There are some with documented performance records going back 20-30 years or longer.
Various studies over the years have shown that the performance of futures Trading Advisors as a group has a low correlation to the returns in stocks and bonds – commodities dance to a different drummer. Thus, an investment with carefully selected futures Trading Advisors can help to diversify one’s portfolio, with the potential to increase returns.
Keep in mind, however, that hiring a professional Trading Advisor does not eliminate the risks in the futures markets. Hiring a professional Trading Advisor also does not eliminate the risk that you can lose more than you invest in most cases. And there’s always the caveat that past performance is not necessarily indicative of future performance.
There are also hundreds of futures funds and pools you can invest in that are managed by one or more of these professional Trading Advisors. Most futures funds are structured in such a way that the investors have limited liability and cannot lose more than they invest.
As with mutual funds, there are good futures funds and there are bad ones. There are services that track the performance of futures funds, and these can be used to identify funds with good performance records.
In recent years, we have also seen the introduction of several mutual funds that track selected commodity indexes, and even some that invest in futures directly.
Only Go With Professional Trading Advisors Or Futures Funds
As should be obvious by now, I do NOT recommend that anyone reading this E-Letter attempt to trade in the futures markets on your own (unless you are an industry professional). The odds are highly stacked against you. The only way I recommend investing in the futures markets is with carefully selected Trading Advisors or in carefully selected futures funds, and this is only if you are financially suitable for such an investment.
With stocks having become so very volatile, and bonds delivering disappointing returns, and with the recent real estate/housing slump, it is alluring to look at investing in the futures markets. The commodity markets have experienced some very big moves over the last couple of years.
Just keep in mind, that the commodities futures markets are very risky. Most people who invest in them on their own lose money, often far more than they invested, based on my years of experience in this industry. So just say no. Don’t go there, despite what you may be told by solicitors.
Fortunately, there are some ways to increase your odds for success. Carefully selected futures Trading Advisors can significantly improve your odds. In my opinion, the best way is to invest in professionally managed futures funds and pools.
Professionally managed futures funds offer several potential benefits. First, most futures funds typically have limited liability for the investors. Second, these funds allow investors to pool their assets, with the potential to access more successful managers whose minimum investment requirements are too large for most individuals. And third, most futures funds can negotiate lower commission rates than individual investors.
While I believe that futures funds are the best way for most investors to go, there are good ones and bad ones. Be sure to read the prospectus (or offering memorandum) carefully. Past results are not necessarily indicative of future results.
Finally, in the spirit of full disclosure, you should know that my company, ProFutures, Inc., manages several multi-Advisor futures funds and has since 1987; our multi-Advisor futures funds are no longer open to new investment.
If you have questions about the futures markets, feel free to call us at 800-348-3601. I hope this week’s information has been helpful.
Wishing you profits,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert, Mike Posey (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.