Why Investors Are Piling Into Commodities

Wondering why commodities are all the rage lately? Well, they have been for some time but they are really in the spotlight now as both a great investment vehicle and as a cause of inflation. So, wny are so many investors betting on commodities? Bill Gross, the head of Pimco, a bond company that manages the largest bond fund in the world, made his reasoning clear in his June 2008 Investment Outlook.

He doesn't believe the government's inflation numbers:

"Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity “miracle” may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world?"

He then goes on to explain why misstating inflation is so insidious in his opinion:

"The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation."

He then summarizes by stating what kind of investments he favors based on this misstatement in inflation:

"With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars."

In plain English, he favors investments in foreign based commodities because he doesn't believe in the US government's numbers and thinks that bonds and equities are overpriced based on these false numbers. Is he right? Probably, although I think markets are quickly realizing the government's numbers are bogus. We've certainly had enough articles written about it on BestCashCow. The government can use any numbers they want to calculate social security payments, but the markets will quickly ascertain the real number. Thus, I suspect the bond and stock markets are already in the process of pricing in the real inflation rate.