Exclusive PIMCO Interview: What Will Drive Commodities Higher for Years?

Intelligent Commodity Indexing is a new book that explains how investors can intelligently use commodities in a portfolio in order to diversify risk and protect against inflation.  Readers will find the book filled with decades of experience from its authors.

The authors include PIMCO executive vice president and real return manager Robert Greer.  Prior to joining PIMCO in 2002, he was with JP Morgan Chase (NYSE:JPM) and Daiwa Securities as a developer and product manager of commodity indexes.  Mr. Greer has more than 28 years of investment experience and invented the first commodity index in 1978.  Mihir Worah and Nicholas Johnson are also authors on the book as well.  Mr Worah and Mr Johnson co manage all of PIMCO’s commodity funds including the $26 billion Pimco Commodity Real Return Strategy Fund. Mr. Worah is a managing director, a portfolio manager, and head of Real Return portfolio management team for PIMCO.  He has nine years of investment experience and holds a Ph.D in theoretical physics from the University of Chicago.  Mr. Johnson, is a senior vice president and a portfolio manager focusing on commodities for PIMCO.  Prior to joining PIMCO in 2004, he worked with NASA’s Jet Propulsion Laboratory, developing Mars missions.  He has seven years of investment experience and holds a master’s degree in financial mathematics from the University of Chicago and an undergraduate degree from California Polytechnic State University.

I recently had the pleasure to speak with Mr. Greer and Worah about the new book and the current economic outlook regarding commodities.

Eric McWhinnie:  Could you please explain your book and how it relates to commodities?

Mr. Greer:  Sure, commodities are moving more into the mainstream as an asset class.  With the recent volatility in the financial markets, investors are beginning to realize the benefits of using commodities in a portfolio to hedge against risk and inflation.  The new book provides knowledge and a more intelligent way of getting value.  It also explains the structure of indexes to readers and investors and how to invest in commodities.

Mr. Worah:  I agree with Robert on his statement that commodities are a good way to hedge against inflation, and would like to add that commodities also diversify an investors portfolio. What we are trying to accomplish is share with readers our decade of experience in managing commodity index portfolio in an ‘intelligent’ rather than in a purely ‘passive’ way. Passively investing in a commodity index has several drawbacks, and we point these out, as well as suggest ways to add value without taking a lot of additional risk.

Eric McWhinnie:  What are the current trends taking place in commodities?

Mr. Worah:  Commodities (NYSE:RJI) have two prevailing trends.  First, central banks in developed markets are using policies to fight deflation.  For example, the Federal Reserve just announced the continuance of low interest rates until 2013.  This makes all real assets look very attractive.  The second trend, which is a crosswind for commodities, is a slowing global economy.  For example, Eurozone issues, fiscal unemployment in the U.S., and countries such as China are trying to slow their economy.

Eric McWhinnie:  What is your outlook for commodities?

Mr. Worah:  Demand is still going to be the driving force behind commodities.  However, in the next six months, we expect to see volatility continue.  Over the next 3-6 months, we are bias towards a slowdown and expect to see easing in prices.  In the long term, 3-5 years, China (NYSE:FXI) and India (NYSE:INP) will be growing markets that will be dealing with decreasing supply.  We expect developed market central banks to continue easing, which will provide support and higher prices for commodities.

Mr. Greer:  We are also expecting volatility to be seen with bonds and stocks.  One of the benefits investors will find with commodity indexing investing, is that when bonds or stocks zig, commodities will often zag the other way.  Commodities are a good way to diversify a portfolio.

Eric McWhinnie:  What are you expecting from the Federal Reserve?

Mr. Worah:  With the highly unconventional low interest rates for another two years, the hurdle for QE3 is high.  Instead, we expect to see a playbook laid out from the Fed with specific steps to stimulate the economy.  These steps may include: Selling short-term instruments and buying long-term maturity bonds (Operation Twist), a broader purchase of bonds amounting to $1 trillion, reducing mortgage rates by mandate, or buying other risky assets.  Nothing will happen fast in regards to the next steps from the Fed.

Mr. Greer:  Long-term, the story is unchanged.  We don’t expect to see QE3 in the near future, but we expect to see a playbook as Mihir described.  The Fed is determined to fight deflation, and more steps will come from the Fed.

Robert Greer and Mihir Worah are authors of the new book Intelligent Commodity Indexing: A Profitable Guide to Investing in Commodities.

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