BULLS & BEARS: Commodities are passé; time to invest in laggards

May 29, 2006

As you may recall from my column a fortnight ago, Bill Miller is the manager of the Legg Mason Value Trust. It's the mutual fund with the longest winning streak vs. the S&P 500-16 years.

In the last column, I shared why Miller believes commodity prices are close to their peak and why he feels commodity stocks, especially oil and metals stocks, are too risky for their potential return.

The rest of this column quotes Bill's quarterly letter to his shareholders, in which he explains where he sees value today:

"The U.S. equity market has lagged those of the rest of the world by a wide margin for several years, and within our market the mega-cap S&P names have lagged the small and mid caps, which are in the seventh year of relative outperformance, quite long in the tooth by historic standards. Part of the reason for the relative lack of interest in U.S. stocks has been the relentless rise in short interest rates. Our central bank has been noticeably more hawkish than the rest of the world, and money has flowed to where money was the easiest, outside the United States. As we end our tightening cycle, and others remain engaged in theirs, our market should become relatively more attractive.

"In a world where global liquidity may be diminishing, relatively illiquid assets are likely to begin to lose their allure. Liquidity will become more valuable. I think the most liquid market in the world, the U.S. market, will become more attractive, and within that market, money will flow to the largest, most liquid names, which also happen to be the cheapest part of our market.

"The excitement and enthusiasm surrounding commodities, and the belief that they will continue to rise, is not surprising. People want to buy today what they should have bought five or six years ago; call it the five-year psychological cycle.

"Today people want commodities, emerging-market, non-U.S. assets, and small and mid-cap stocks. Those were all cheap five years ago and had you bought them then you would be sitting on enormous gains. But five or six years ago, everyone wanted tech and Internet and telecom stocks, and venture capital and U.S. mega caps. The time to buy them was in 1994 or 1995, when they were cheap. But in 1994 or 1995, people wanted banks, and small and mid-caps, which should have been bought in 1990, and well, you get the picture.

"In general, you can get a good sense of what to buy now by looking to see what the worst-performing assets or groups were over the past five or six years. That is long term for most people, and long enough to convince them that the malaise is permanent and to have migrated their money elsewhere, such as to whatever has done best in the past five or six years.

"Given the choice of buying Commodities with a capital C, or buying [Citigroup, whose ticker symbol is C]-at current prices, I'll take the latter. Check back in five years."

Gilreath is co-owner of Indianapolis-based Sheaff Brock Investment Advisors, money management firm. Views expressed are his own. He can be reached at 705-5700 or daveg@sheaffbrock.com.
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