Investing Genius Makes Big Bet on Commodities

What if you ran a mutual fund whose sector focus was on housing, yet you were selling your homebuilding positions and buying, of all things, commodities. Would you be mad? Or a genius?

Such is the reality for investors in CGM Realty Fund, run by Kenneth Heebner, who Fortune Magazine called an “investing genius” last year. He started buying copper companies two years ago. From Fortune:

Are you surprised your bet on copper has paid off so well?

It’s gone up more than I thought it would, but there’s a real supply-demand imbalance. Copper goes into the infrastructure of all developing nations, of which India and China are the most publicized but not the only ones. Copper production hasn’t been able to grow fast enough to keep pace with demand. When you look around the world today, the earliest we can see incremental new production coming online is 2009 or 2010.

Now one of the things that usually happens when the price of a commodity rises like this is you get demand destruction. But in the case of copper, 75 percent of its use is for wiring, and there aren’t good substitutes. Aluminum and silver have superior conductivity, but silver is much too expensive, and aluminum isn’t practical, because it’s bulky. So you’re not seeing demand destruction in copper, and when you don’t have demand destruction, prices keep going up.

So you’re sticking with your copper stocks [like Phelps Dodge (Charts) and Southern Copper (Charts)]?

I look at the prevailing expectations. There is nobody I know of who’s forecasting that the price is going to stay this high [$3.54 a pound in early June]. The consensus estimates are for a sharp decline down to around $1.50 a pound.

Which you actually see as bullish.

Yes. It encourages me because I have reasons why I think it won’t go down. That said, I don’t have same level of conviction as I did last year.

He ties the commodities sector to real estate by arguing that you need commodities to build housing (obviously copper piping etc.). But in reality, he is investing in the sectors he knows are going to make money. From Bloomberg:

He’s buying shares of mining companies that benefit from growing infrastructure needs in India, China and Russia. CGM Realty Funds also holds shares of Las Vegas Sands Corp., the casino operator that is developing real estate in Macau, China, and Mexican homebuilder Desarrolladora Homex SAB.

Heebner is known for making concentrated investments in a few industries. He sold homebuilders after owning them from 2001 to 2005, record years for home sales. He bet against technology and telephone stocks in 2000, correctly timing their collapse.

Interestingly, the part of the Bloomberg article that got the most play was this quote, discussing how housing prices will fall by 20%:

“It will be the biggest housing-price decline since the Great Depression,” Heebner, 66, said today in an interview in Boston. Prices may fall by a fifth in some markets, he said.

Some in the media went ballastic refuting this quote (arguing “not in my neighborhood/city/town/state.”) They’re focusing on the wrong part of the interview. Investors should watch what he’s investing in, not what he’s saying is going to tank. And follow his lead. He has a track record to back him up. From Fortune:

Today he manages $6.6 billion, most of it in four CGM mutual funds: his flagship Capital Development (now closed to new investors), Focus, Realty, and Mutual, which holds a mix of stocks and bonds.

Realty has the best three-year, five-year, and 10-year returns in its Morningstar peer group. Focus has returned 30.5 percent annually over the past three years. And while Legg Mason’s Bill Miller may be the fund world’s brightest star, Heebner’s Capital Development fund has actually outpaced Miller’s Value fund since the latter debuted in 1982.

Going back further, in the 30 years since Heebner took over the fund in 1976, Capital Development has trounced the S&P 500, gaining an average of 17.2 percent a year, vs. 12.8 percent for the index.

Take heed. Commodities are now where it’s at- even for real estate investors.