The Best Asset in a Time of Volatility

All markets are volatile these days.  Stocks are gyrating, bonds are falling as interest rates increase, oil is bouncing up and then down, bitcoin has fallen all year, and even the real estate market seems to be going wobbly.  Gold and silver have been slipping away.  And foreign markets look even gloomier.

Investors naturally look for opportunities when prices fluctuate.  Whether you're a buyer or a short seller, price movements create the potential for profit.  Volatility is gut wrenching if you're taking losses, and can stimulate panicky selling when prices are low.  But it can be exhilarating if it looks like a lucky break.

That's why cash is often the best asset to hold in a time of volatility.  It gives you the means to take advantage of fortuitous price movements, while its stability insulates you from the emotional roller coaster that often drives people to sell when prices are dropping.  Don't think that you have to remain fully invested all the time.  What you have to do is remain unemotional, as emotion is the enemy of careful investing.  A nice, comforting cushion of cash can prevent an unwanted flood of adrenaline.

Cash may appear to have a low rate of return, with greedy banks still paying miserly rates of interest on deposits even though interest rates have been rising.  But cash also offers the potential to profit from price volatility.  You can dive into an asset when its price is low and make a bundle when it rebounds.   That potential makes the effective return from cash much higher.  So don't be afraid to hold a lot of cash in a time of volatility.  That's when it's an investor's best friend.

The EU Sovereign Debt Crisis: There Are No Safe Havens

The EU sovereign debt crisis has metastasized in two weeks from being a problem with Greece, to being a problem with Italy, Spain and France. Bond yield spreads for the debt of these much larger countries are widening away from German bunds. The dollar is once again dearly loved in the capital markets in spite of the Federal Reserve's persecution of positive returns on dollar denominated loans. The EU's much touted expansion of its bailout fund to over one trillion Euros is d.o.a. With the large Romance language speaking nations on the cart approaching the guillotine, a trillion or two just doesn't amount to jack, especially since this proposal was simply another paper shuffling shell game to flim flam creditors into believing that swapping new EU debt for old debt was somehow in their interest. The EU's overall ability to repay has been deteriorating. Why would new debt be attractive?

With all the turmoil, one would think that gold would be skyrocketing in value. But it hasn't. Since reaching its peak of $1923 per ounce this past summer, gold dropped below $1600 and has recently meandered around in the $1700s. As we discussed in September (see http://blogger.uncleleosden.com/2011/09/why-gold-isnt-safe-haven.html), gold is intimately linked to financial assets, and derives its value from financial market interactions. It's no safe haven.

Nor is anything else. Countries that are viewed as having sound currencies, like Switzerland, have been intervening in the currency markets to keep their exchange ratios down. Otherwise, capital will flood in, drive up the value of their currencies, and wreck their export businesses.

Weirdly, the U.S. dollar has by default remained the world's safe haven. If nothing else, investors know that, in the worst case, the U.S. Treasury will conspire with the Fed to print however much money it takes to pay America's debts. The Congressional Supercommittee tasked with reducing the federal deficit is on the verge of belly flopping. But the financial markets remain sanguine, evidently believing that capital has nowhere else to go.

Why Gold Isn't A Safe Haven

In the past couple of days, gold has dropped close to 10%, and is now trading around $1650 per ounce. That's 15% down from its recent peak price of around $1920. Why the belly flop? The answer is that, contrary to pronouncements of bug-eyed gold fanatics who drool from the sides of their mouths, gold is not a safe haven from fiat currencies or the financial system. Instead, it is joined at the hip with the financial system.

Among the most active traders in gold are hedge funds and other financial firms. These market players mainline leverage. And when they can't find a vein, they smoke the stuff. Consider the nature of leverage. It's a loan denominated in fiat currencies like the dollar and the euro. Leverage must be repaid in fiat currencies. Banks extending margin loans don't want to speculate in gold themselves, so they require repayment in dollars, euros or some other fiat currency.

Leverage financed the great gold rush of 2008-2011. This time, prospectors didn't search for yellow metal in stream beds or under the ground. They sought riches in the trading platforms of exchanges. The ones that got into the market two or three years ago hit the motherlode. But as gold bubbled up, smart players began to wonder when the party would run out of punch. The financial crisis of 2008 taught us that bubbles will burst at some point. Stocks and real estate both bubbled up and burst, and gold isn't different. Part of today's selling is to lock in profits while the getting is good. Locking in profits involves converting gold holdings to a fiat currency. That's the only way to take your gold profits and use them to repay margin loans, and buy cars, food, housing, and so on. So when money managers think the gold bubble, as valued by fiat currencies, has peaked, they will sell gold in order to obtain fiat currencies.

Other hedge fund managers may be selling gold because their investors, seeing the world go hinky in recent months, are making redemption requests to cash out. Investors may be worried about stocks, oil, or other assets besides gold that the hedge funds invested in and are now falling in value. But gold is easier to sell than some assets because it has a highly liquid market. So investor redemption requests, in effect, hit the gold market. Investors want payments in fiat currencies, not distributions of gold. That means the gold has to be sold to convert it into fiat currencies.

The players who dove into gold also traded on a leveraged basis in stocks, other commodities and maybe derivatives that no one can easily learn about because the derivatives market, three years after the financial debacle of 2008, remains opaque. Part of the selling of gold is due to speculators having to raise cash to meet margin calls resulting from falling prices for stocks, commodities other than gold (such as oil, which has lost some of its sheen) and, perhaps, derivatives contracts. In this way, leverage used to invest broadly on a diversified basis can have an interlinked downward impact when some markets go wobbly.

The recent woes of the euro add to the problem. A fall by the euro has pushed up the comparative value of the dollar. Since gold tends to trade inversely to the dollar, a good day for the dollar means a bad day for gold. That's another reason for gold investors to bail before they sustain more losses. The inverse correlation between the dollar and gold reveals a vulnerability of gold to a fiat currency.

With the financial markets and world getting hinkier by the trading minute, the selling has accelerated in the past two days. The ship seems to be sinking, and you know who is scrambling to get off first. Leverage dramatically pushed up the price of gold, and now deleveraging and other financial factors are driving it down.

Today's gold market is a creature of the financial system, and is subject to the same pressures and constraints as other assets. Gold isn't a safe haven. What is? That's the question people have been asking since they sharpened long sticks for protection and sought shelter in caves. When you have the answer, please clue in the rest of us.

Still Searching for the Gold Standard

Contrary to popular belief, the gold standard lives on. Not as a linkage of paper currency to a precious metal, but as the human search for certainty in the value of currency. And the results today are as convoluted as earlier experiences with the gold standard.

The gold standard--making a unit of a paper currency convertible into a fixed amount of gold--was used first and foremost to provide assurance against uncontrolled printing of money and the inflation that could follow. Such inflation could be created by whoever issued the paper money--be it a bank or a government--and gold convertibility was seen as stabilizing the value of the currency.

Gold, however, doesn't ensure absolute certainty of value. When large amounts of gold become available (from mining or other sources), price inflation can result. The Spanish conquest of much of Central and South America in the 1500s resulted in massive amounts of Aztec and Incan gold and silver flowing to Spain. Price inflation followed, even though Spain used gold and silver currency.

Gold as a reserve for paper currencies has not always provided a foundation for stability. In the 1930s, central banks protecting the gold standard acted too conservatively to combat the growing economic depression. In doing so, they may have aggravated the deflation that resulted from the stock market crash and accompanying economic downturn, which in turn hindered recovery from the depression. Eventually, the U.S. and other nations had to devalue their currencies to help foster recovery. What happened here was that the nation issuing the currency had gone into a depression and the real world value of its currency had correspondingly fallen. The conversion value of its currency into gold had not changed, so the currency was overvalued and deflation ensued. Ultimately, the gold standard did not prevent paper currencies from falling in value because paper currencies takes their true value from the economic strength of the issuing nation.

Gold can serve as a currency because people think it's valuable and accept it as a medium of exchange. The same is true for anything people accept as valuable--tobacco, cotton, deer skins, beaver pelts, sea shells, and American cigarettes all have served as currency at various times and in various places.

People want their currency to be stable. It doesn't really matter what is used as currency. Most currency today consists of electronic entries in computer systems. But people believe these little bits and bytes of data have value, so they accept them as a medium of exchange.

What hasn't changed from the days of the traditional gold standard is the desire for certainty. And that's the problem. The Euro bloc, in which 16 nations have adopted the Euro as a common currency, is simply a reincarnation of the gold standard. By adopting the same currency, issued by a central bank that supposedly must limit its responsibilities to maintaining the value of that currency, the Euro bloc nations hope for an island of stability in the raging seas of the currency markets. But these nations can't reach Avalon unless all members row their oars together and pull their own weight. That hasn't been happening and the ship is foundering.

China and other nations that link the values of their currencies to the U.S. dollar also seek to create a latter day gold standard. Although now a distant memory, there was a time (the 1970s and 1980s) when the dollar was seen in some parts of the world as rock solid. In the Soviet Union and Communist China, U.S. currency was coveted and hoarded, while local currencies were regarded with suspicion and disdain (China has a long history of currency inflation). As China integrated market forces into its economy, it linked its currency to the dollar, not as an export weapon so much as an anchor against inflation. Some Latin American nations that struggled with inflation did the same thing at various times. (Most notable among these were Argentina and Mexico.)

China's dollar link was crucial to its ability to grow. It removed the risks of currency fluctuations, encouraging American businesses to invest in China. The Chinese very much wanted American investment in order to obtain American know how and technology. The intellectual capital gained by China from American (and other foreign) investment leveraged its rate of growth. On its own, China could never have achieved prosperity as quickly as it did.

Of course, as China grew, its currency became more valuable in relation to the dollar and China's dollar link conferred an exporting advantage that is now essential to its economic model. Despite increasing inflation and foreign political pressure, the Chinese want to protect their exporters, because they don't have internal markets to substitute for the export markets they would lose from a stronger yuan. To combat inflation, the Chinese have employed alternatives, such as higher reserve requirements for their banks, price controls, consumer subsidies and sales from state food reserves (the latter a tradition from the days of dynastic China).

Americans shouldn't think that their own government isn't implicated in China's search for a contemporary gold standard. The U.S. government was for a time quiescent about China's exchange rate policies in order to encourage China to ally itself with America against the Soviets, and to open up China to U.S. investment. Moreover, the inflow of inexpensive Chinese goods has helped keep inflation low in America, which in turn permitted low interest rates and booming real estate values. Okay, so not everything turned out wonderfully, but the 2008 financial crisis wasn't the fault of the Chinese. Indeed, they lost money investing in American mortgage-backed securities.

In spite of the financial turmoil of the past three years, Europeans and Asians still cling to their gold standards, looking for certainty in the value of currencies. Gold standards can have short term benefits. Long term, economic conditions change and so do currency values. The squabbles of the Euro bloc over bailouts, quantitative easing, haircuts for creditors and the growing disquiet of German taxpayers, are a struggle over who will bear the costs of maintaining Europe's latter day gold standard. China's accumulation of a vast hoard of U.S. debt securities (and their attendant investment risks), along with the fiscal costs of consumer subsidies and state-owned food stocks, are China's costs of maintaining its 21st Century gold standard.

The gold standard protects savers, investors and creditors. Pure fiat currencies tend to favor borrowers and spenders. Thus creditor nations prefer a gold standard. Borrowing nations argue for free-floating currency rates. A gold standard doesn't necessarily favor exporters--they are better off or not depending on where the exchange or conversion rate is set. The Euro bloc includes both creditor nations and borrowing nations; hence the conflicts that may yet cause the Euro to collapse. The dollar bloc similarly includes creditor nations and borrowing nations; its tensions, too, are palpable.

Ultimately, there is no permanent gold standard or other absolute reservoir of value. The never-ending quest for certainty is trumped by the incessant process of change, mutation and evolution in the economy. (See http://blogger.uncleleosden.com/2010/06/what-if-economy-is-creature.html.) But the process of human advancement can be said to be a long struggle for certainty. Deliverance from the vicissitudes of hunting and gathering, the extremes of the weather, the unpredictability of farming, the dangers of aggressive peoples, the horrors of plagues and other deadly illnesses, the volatility of the business cycle, and the capriciousness of financial markets all underlie the imperative for human advancement. All the bug-eyed, rifle-cleaning, ridge-dwelling, fringe group wackos panting for the gold standard can wipe the drool from the sides of their mouths and rest easy. It's alive and kicking, and will continue to bedevil central banks, high ranking government officials, policy makers, business executives, and the rest of us as far into the future as one can see.

China's Take on Gold

Late last week, China's central bank announced that it would not buy gold as part of its asset allocation strategies. http://www.cnbc.com/id/37610078. It cited the gold market's small size, illiquidity and volatility as reasons.

This decision should serve as a warning to gold bugs. The Chinese have issued currencies (first metal and then paper) for thousands of years. They also possess the accumulated wisdom and experience of a civilization that continually existed those thousands of years. China suffered from inflation and financial speculation before Columbus, the Vikings, or whoever discovered America. They know a bag of . . . well, can of worms when they see one.

China has an enormous investment problem. It probably holds more of the world's financial assets than any other single investor, and is engaged in a uniquely difficult search for value. American financial advisers and money managers look for and promise (morally, if not legally, speaking) positive gains, perhaps a tacit reflection of America's singular success in growing geographically and economically during its short existence. The Chinese understand from long experience that, at times, survival is the priority and positive returns may require more risk than is prudent. They largely avoid stocks, and mostly stick with government bonds and other high quality fixed income investments. They didn't abandon the dollar when it sank in relation to other currencies, and haven't abandoned the Euro even though it's sunk in relation to other currencies. They aren't trying to avoid all losses, but seek stability until they can re-focus their economy toward growth based on domestic consumption.

Why would they be uninterested in gold, even though Chinese emperors first coined gold thousands of years ago? Their announced reasons tell the story. Gold can't serve the needs of large-scale modern investment. There isn't enough of it. Most of the value in today's world economy is embodied in securities (like stocks and bonds), bank accounts and other cash equivalents, real estate, and private ownership of businesses. Gold is a fringe investment, whose aficionados sometimes include members of one lunatic fringe or another. It can skyrocket in value, and just as easily nosedive.

Some central banks have increased their holdings of gold in the last few years. But China's decision to avoid investing in the gold market takes a potentially huge buyer out of the picture. Buy gold if you like. Just remember that your sharing the gold market with some semi- or fully whacked out people, and anything can happen. Gold tends to rise in price during times of stress; hence its popularity in recent years. But it won't hold its value after the crisis passes. That was the case in the early 1980s. Your holdings of gold will attain lasting value only if civilization collapses. Give our regards to the Mad Hatter if you think that's going to happen.

Still Searching for the Seven Cities of Gold

Suddenly, gold has become the hot new investment, reaching over $1,200 an ounce (in dollar terms) for the first time. Does this make gold a good investment? Consider history.

For the Spain of the 1500s, the New World was a fantastic tale of unimaginable wealth come true. In 1519, Hernan Cortes conquered the Aztecs, securing astonishing amounts of gold and silver, as well as vast territories. Next, Francisco Pizarro and his brothers conquered the larger Inca Empire with even fewer men than accompanied Cortes. Unfathomable amounts of gold and silver flowed to Spain, which had grown in the space of 50 years from a medium sized European kingdom to the enormous Spanish Empire.

As vast fleets of galleons transported gold and other wealth to Spain, inflation set in on the Iberian peninsula. Gold wasn't a magical store of value and wealth. Nevertheless, the Spanish Empire dedicated itself to obtaining as much gold and silver as possible, through conquest and then mining. Latin America, a region with tremendous amounts of natural resources, wasn't developed in the way of North America. By the end of the 19th Century, North America was an industrial powerhouse. The Spanish Empire was bankrupt.

Gold isn't a productive asset. Its only value lies in what it can be exchanged for--i.e., what other people think it's worth. In times of distress, it has value. With the Euro in decline from the sovereign debt crisis in Western Europe, the dollar wavering because of the financial crisis and recession in the United States, and the absence of any strong currency in wide circulation in Asia, gold has by default become popular.

Gold doesn't produce prosperity. It can be a good short term trading play, if your timing is right. But the value of gold is affected by innumerable variables--economic, political, cultural, commercial and industrial (there are a few industrial uses for gold)--and its price trends are notoriously difficult to predict. Gold has done poorly as a long term investment--adjusted for inflation, today's prices are not gold's all time peak (that would be the 1981 price of almost $600 an ounce, which translates to about $1,400 an ounce today). In the last 35 years, the stock market has done about twice as well as gold.

People become wealthy by working, earning, saving and investing, not by speculating in gold. Countries become prosperous by industrializing and strengthening their manufacturing abilities. The Spaniards who searched for the legendary Seven Cities of Gold (or Seven Cities of Cibola) roamed through vast areas of what are now the plains of the United States. They didn't find any gold, and they didn't recognize that the dry grasslands through which they marched would some day become part of the wealthiest nation in the world. They were searching for the wrong thing, and so are today's investors who think they've found a panacea in gold.

Is the Federal Reserve's Free Ride Ending?

The announcement on Friday, Dec.4, that the unemployment rate had fallen slightly from 10.2 % to 10 % surprised many, and perhaps dismayed some at the Fed. At its Nov. 3-4, 2009 meeting, the Fed announced that it expected to keep the fed funds rate at "exceptionally low" levels for an "extended period" of time. That announcement helped to fuel stock and commodities prices for the month of November. But after Friday's announced unemployment drop, stocks closed with only a modest gain, gold fell 4%, oil fell a little over 1% and the 10-year Treasury note fell about 0.75% in value (with an increase in yield of about 10 basis points). The dollar rallied.

These market reactions were spurred by the implication that the Fed will have to raise interest rates sooner than it expected. An interest rate hike would strengthen the dollar, reduce the value of gold, and push bond yields higher (and bond prices lower). The price drop in oil--seemingly odd because a recovering economy would be expected to consume more oil--is a reflection of the asset bubbling spurred by the Fed's cheap money policies. The huge amounts of cash pumped by the Fed into the financial system pushed down the dollar, thereby making oil more valuable in dollar terms. If the Fed begins to pull back on its accommodation, thereby strengthening the dollar, oil prices in dollar terms would naturally abate.

The Fed's predictive powers have been demonstrably lacking. It failed to see the implications of the growth in the mid-2000s of looney mortgages (the kind given to people who couldn't repay), the misplaced risks and rewards of the securitization process (where Wall Street made monstrous amounts of money from doing deals--including excessively risky deals, recklessly stupid deals and irredeemably bad deals), the increasing opacity of the financial system's true condition caused by derivatives and then derivatives of derivatives, and finally the monumental blockheadedness of concentrating at AIG credit default swaps insuring hundreds of billions of dollars worth of mostly mortgage-related investments. One wonders whether the Fed has underestimated the pace of the economy's recovery.

On one level, we hope it has. Continuation of the Great Recession much longer could inflict lasting damage to consumers, workers, businesses and investors that might lead to the stagnation that has bedeviled Japan since its massive asset bubble burst in 1989-90. There, people seem to have lost faith in just about everything except the government. This was most recently demonstrated by the Japanese government's cancellation of plans to privatize its postal system (which is not only a mail carrier, but an enormous bank and insurance company). The U.S. government's greatly expanded role in the economy could easily become permanent if the private sector doesn't revive soon.

But a Christmas present in the form of improved economic performance could lead to volatility in the financial markets. A lot of players (they used to be called investors, but today long term investing is about as trendy as a large SUV) have borrowed dollars at cheap, short term rates, converted them into other currencies and invested in longer term plays denominated in other currencies. Or else they invested in oil or oil futures, betting that continued bottom of the barrel interest rates would push oil prices ever higher in dollar terms. Or they took heart from the Treasury securities market's improbable rally this year and the Fed's ongoing trillion dollar program to buy Treasuries and mortgage-backed securities, and used cheap borrowed money to purchase higher yielding long term securities they thought would be propped up by the Fed's massive money print. Or they jumped into the stock market with the hope that the Fed's gusher of liquidity would continue to push stocks higher, even after a 60% rally this year.

All this activity was premised on the Fed correctly foreseeing economic stagnation and keeping short term interest rates virtually at zero, as it publicly proclaimed. If the Fed again turns out to be wrong, and has to hike rates sooner than expected, a lot of free rides will end. The players who have borrowed short and invested long may well have to unwind their positions, learning the hard way that not matching the duration of your borrowings with the duration of your investments entails risk. That could lead to volatility in the financial markets. If the volatility begins to create systemic problems, the credit crunch could again rear its hideous head and banks may again become catatonic. Then we'd probably have the much feared double-dip recession.

The Fed meets again on Dec. 15 and 16, 2009. Don't expect any rate hikes then. But the Fed may be compelled by continuing good news to modify its promise (that's how financial markets players have been viewing it) of ultra low interest rates. If it does, the speculators in the financial markets might have to make painful adjustments (as they probably already are).

Even as the Fed for the past year has given banks and other financial market participants a virtually free ride on borrowed money, it's gotten a free ride in terms of monetary easing. With banks making almost no new loans and pulling back existing credit, no amount of Fed accommodation seemed to have any impact on consumer prices. The Fed could keeping shoving printed money off its loading dock and not pay the price of monetary policy gone wild.

But the law of unintended consequences always lies in wait to ambush federal economic policy. The Fed didn't intend for its monetary easing to stimulate asset speculation here and abroad, even though it should have been sensitized to that risk by its role in the pumping up the real estate bubble. Chairman Bernanke's pledge of greater transparency of the Fed's thinking is a good idea. But when the Fed starts to play that most dangerous game--publicly predicting the future course of the economy and interest rates--it had damn well better be right. Or the rest of us will pay the price.

Gold and Financial Stocks: Markets as a Form of Expression

In recent days, the financial markets seem to have gone gaga. Gold is approaching $1,000 an ounce again. Bank and other financial stocks have rallied. The two trends are analytically inconsistent. Gold is favored when the economy is falling apart, inflation is surging or the political situation is deteriorating. In other words, it's an investment of last resort. Bank and other financial stocks make the most sense when economic trends look rosy. Since banks and other financial institutions lend to or invest in large segments of the economy, it is logical that they would rise when the picture looks good.

When both gold and financial stocks rise, cognitive dissonance sets in. But only if you assume markets are rational and interrelate with each other. While there may be a vague and general relationship between gold and financial stocks, for the most part, they are separate venues where different opinions are expressed through trading activity.

Markets require differences of opinion to function. Someone has to prefer cash to a stock, bond, gold or what have you, in order to sell. Someone else must prefer to own the stock, bond, gold, etc. instead of cash, in order to buy. These differences of opinion are the foundation for the supply and demand that interact in markets.

But different markets don't necessarily reflect the thinking of the same people. People who think inflation is around the corner and the economy is headed for a double-dip recession are snapping up gold. But they're very likely not selling or shorting financial stocks. People who see green shoots at every turn are speculating in financial stocks. But they're probably not selling gold or shorting gold stocks. Just as there is no unified field theory in physics, there is no unified financial market. Instead, gloomier investors express their opinions in one market. Optimistic (or opportunistic) investors express their views in a different market.

If you're trying to figure out what's going on, don't look for overarching explanations of all market activity. The last three times gold approached the $1,000 an ounce range (March and May of 2008 and February 2009), financial stocks were wobbly. Now, almost irrationally, they are not. What really seems to be going on is that in the low volume trading of the pre-Labor Day vacation period, different investor opinions are being expressed in different markets. These views can't easily be reconciled. Perhaps the most they indicate is the likelihood of greater volatility in the near term future.

Disagreements are a natural part of market activity. Avoid reading a lot of significance in recent gold and financial stock price movements. Gold reached the $1,000 range three times in the last 18 months, yet mobs don't rage in the streets and the Constitution remains the law of the land. The revival of financial stocks doesn't necessarily mean that all will be well. The financial markets are heavily populated with soothsayers and diviners that attribute talismanic significance to price movements of particular investments. There is no all-knowing indicator in the markets. There's simply the usual cacophonous potpourri of humanity.

Commodities for Individual Investors

The global economy has grown vigorously in recent years, and the prices of commodities have risen sharply. We all know about oil and gasoline prices. Gold, uranium, silver, corn, cattle, and soybeans have also seen significant price rises. Rising prices attract investors the way shiny objects attract magpies. Nowadays, some people see commodities as the next hot thing. Are they a good idea?

1. Commodities Futures Contracts. The traditional way of investing in commodities is to buy a futures contract. Some view these contracts as a way to make fast money because you can buy one for only a 10% downpayment, or maybe even less. If the contract rises 10% in value, you have a 100% return on your investment. But the reverse is also true: if the contract drops 10% in value, you just lost everything you invested. Further, it's important to understand the nature of futures contracts. You either commit to buy a fixed amount of the commodity at a predetermined price, or to sell a fixed amount of the commodity at a predetermined price. The contract will specify a date on which you have to fulfill this obligation to either buy or sell, called the settlement date. You are locked into the contract--you must buy or sell at the specified price on the settlement date. There is no exit. This is the kicker in commodities futures contracts. If you are in a losing position on the settlement date, you have to take the loss (which could mean forking over more cash in addition to your downpayment if the contract has dropped by more than the value of your downpayment). When a stock drops, you can hold onto it in the hope that it will rise again. When a commodities futures contract is a loser on settlement date, you are stuck with the loss.

Big players in the financial markets can have a hard time figuring out which direction commodities prices will move. Remember the hedge fund called Amaranth, which collapsed because it guessed wrong on the direction of natural gas prices? Individual investors have an even harder time figuring out where commodities prices will go. Some individuals have lost $1 million or more playing with commodities futures contracts. You should avoid them.

2. Stocks with commodities exposure. A safer way to invest in commodities is to buy stocks of companies that have significant interests in commodities. The oil companies are obvious examples. Their stocks have generally done well with the rise in oil prices. Of course, part of the return from investing in oil companies comes from the skill (or lack of skill) of its management and other factors. But if you're looking for a commodities play, oil companies and other natural resources companies are a much safer way to make that bet than a futures contract.

3. Mutual Funds and ETFs. There are mutual funds and ETFs that specialize in providing investors with a chance to profit from commodities by investing in a portfolio of companies with interests in commodities. Since these funds are diversified to some degree, they may be less risky than the stocks of individual companies. They are certainly safer than futures contracts. Of course, you must consider their fees and expenses, as you always would with any mutual fund or ETF.

4. Mattress Stuffers. If you flirt with survivalist tendencies, you can buy gold coins. The 1 ounce 24 carat coins issued by some nations provide a convenient way to own gold--there's the American Eagle, the Canadian Maple Leaf, the South African Krugerrand, and the Australian Nugget. All can be purchased for a little more than the spot (i.e., cash) price of gold in the wholesale market. Owning gold coins presents problems of storage and insurance. And you should buy from a reputable dealer because most people can't tell gold from a bunch of other substances. But if you think the end of civilization is near--or you just want the fun of having some gold to stare at--you can buy gold coins and stick them in your mattress, or in the closet along with your freeze-dried food, bottled water, portable generator, camping gear, compass, flint and steel, tomahawk, coonskin cap, and Pennsylvania long rifle.

Is it a good idea to invest in commodities? If you put a small portion of your portfolio (5% or maybe even 10%) into commodities, you might acheive a degree of diversification that could pay off. Remember, however, that commodities prices are notoriously difficult to predict, and the financial markets have seen long stretches of time when commodities were not winners. Numerous investors have done just fine without investing in commodities.

Crime News: hot dog vendor arrested for parking meter scam. http://www.nbc4.com/news/13716705/detail.html?dl=headlineclick