Black or transparent gold for you _ and a silver lining? Fossil fuel commodities such as oil and natural gas may be just the ticket for investors looking for a high return in a low-yield environment. But beware of the inherent volatility in these risky assets.
Although I talked about gold as a currency in "Net Worth" on March 31 ("Will gold protect you from the perfect storm?"), the disadvantage of gold as an investment is its high volatility, and there is a great deal of emotion attached to the commodity.
Commodities generally do not pay cash dividends, so investors must hope to profit from variations in their capital value. They are always subject to global supply and demand factors that can be complex and difficult to understand.
Gold is the holy grail of currencies in that if you compare its value to any other fiat currency ever issued, it wins hands down at holding its value. Structured or paper-based fiat currencies have often crumbled or have been purposely devalued because they are not actually backed by any real substance.
The value of gold can certainly be very volatile, but because of the invariable emotional attachment, investors tend to hang onto it for very long periods. The biggest examples are global central banks, which believe that if gold prices decline they will most definitely increase again in the future.
What about other commodities available today? While it is highly unlikely they will be reduced to zero value because they have physical substance, finding prices low enough and projected gains promising enough to entice investors into making a purchase is another matter.
Repeatedly referred to as black gold, oil is one of the most important commodities in the world. Five years ago the price of a barrel of oil rose to US$147. Many felt that was a new floor and it was going to go much higher. Oil then suddenly took a nosedive when the recession started. Behind all this was the fact that although the price was high, producers were actually unable to pump further supplies into the markets to take advantage of the value at its highest. US oil production actually declined from 2000 to 2008.
Fossil fuel was thus becoming scarcer and this was surely going to affect the world markets. Indeed, oil prices affect almost everything. But quietly in the background a new technology was developing which extracts oil from shale. There were massive strides in horizontal drilling and hydraulic fracturing, or affording. This has made oil production economically viable and led to a boom in the Bakken region covering the US states of North Dakota and Montana and part of the Canadian province of Saskatchewan. This has opened the region up to much wider possibilities of development. The result is that North America now has far more oil reserves than we imagined just a few years ago.
The US is now moving rapidly toward self-sufficiency in oil. Last year oil imports to the US declined by a million barrels per day. The success of this new energy revolution is quite astounding. American infrastructure is built for the use of oil. The entire economy has been developed around oil consumption. There has been no significant move toward developing a setup for natural gas consumption _ yet.
Natural gas could be described as transparent gold, as opposed to black gold. It is certainly an alternative fossil fuel that is environmentally far cleaner than oil or other fossil fuels, such as coal. We sometimes forget the significance of coal and its common and widespread use for power generation. Natural gas is a perfect alternative and would make a great deal of difference to the global environmental impact.
During the past three years natural gas has declined in price as a commodity because it is difficult to store and has been discovered in abundance. Production is limited to the storage capability and difficult transport requirements make it even more problematic to deal with. Thus the supply has outstripped demand and prices have declined.
However, as the best alternative clean fuel it is going to be of high value in the future. In fact there has already been substantial investment into the development of its use within industry. For example, Warren Buffett is apparently testing natural gas locomotives for his railway, and the development of natural gas filling stations is underway in the US. Five years ago natural gas prices peaked at more than $13 per million British Thermal Units, then they plummeted to below $2 at one point. Currently at around $4 (115 baht), this commodity is thought to be set to make some great profits over the medium term.
Of course, this means an investor must have patience and sit tight while waiting for the boom to happen. This is sometimes a very difficult thing to do, but perceptive investors understand the situation and sit out the arduous wait. Some sceptics say "if" the boom happens, but the majority of analysts agree that it is a case of "when" rather than "if".
When I wrote about gold last month, some readers said that silver is actually a far better precious metal investment option at present. I agree and I dutifully pointed out that my aim then was to discuss currencies. However, I do feel that silver, as a commodity has recently declined in value for no apparent or justifiable reason.
In the past six months, prices have dipped from $35 to $27 per ounce. During 2010-11 silver prices shot up very sharply from around $18 to nearly $45 per ounce. They have now fallen back and look set to be a possible winner for investors over the next year or two.
Of course commodities are very volatile and have high risk and reward factors. A few dollars per unit on oil, gas or silver holdings could take your portfolio to dizzying heights. On the other hand, you may experience a sharp decline and need to wait for a relatively long time before getting back into the black. There can certainly be value in making investments into such areas as these but you need to have the stomach for volatility.
Some investors feel that taking these types of risks at the present time is not such a bad way to try and make some headway in their portfolios. In some ways this seems preferable to the kind of offshore dealing that busted Cyprus banks.
As mentioned last week, it's very difficult to name any holding that can truly be considered safe these days.
A chat with your adviser can reveal possibilities that could lead to a change in strategy within your offshore personal portfolio bond which are very simple to implement.
Andrew Wood has been an expat in Asia for 33 years and is executive director of PFS International. His articles, which cover the complete A-Z of financial planning, are available through the PFS library to readers on request. Questions to the author can be directed to PFS International on 02-653-1971 or emailed to enquiriesthailand@fsplatinum.com.