In addition, the market turmoil of the past two years caused new financings of commodity exploration and development projects to become next to non-existent, so these imbalances have been exacerbated.

Ultimately, the message is the supply / demand imbalance has created a recipe for longer-term commodity price strength. It appears all the ingredients are in place for this longer-term secular theme to play out.

Using oil as an example, here are some points to consider:

• If China and India per capita consumption grows to levels similar to Mexico’s current consumption, global demand would increase by over 36 million barrels per day. This would require the equivalent of three more Saudi Arabia’s to meet this demand.
• Future oil demand will come from developing countries. For example looking at global energy demand from 2005 through 2030, it is projected that OECD (Organisation for Economic Co-operation and Development) countries will show a 19% increase while Non-OECD countries will show an 85% increase.
• Supply constraints support ‘higher for longer’ prices in oil.
• Oil reserve decline rates are getting higher, and the costs of getting oil out of the ground are increasing (the oil sands being a good example of this).
• Even if large-scale investment resumed immediately there is a time lag before commodities can get to market, so this makes it very likely that we will see most commodity prices go higher in time.

An argument against commodities in the long-run requires a belief that the U.S. economy will implode, China and India will not grow, and the wealth effect caused by the growing middle classes in developing economies around the world will not occur. 

In my humble opinion, it would be a large stretch to see all of the aforementioned scenarios not play out.

 However, long-term Investors who choose to sit in perceived ‘safe’ investment like savings accounts, CDs and money market funds should realize that the historically low yields are likely going to leave their portfolio returns flat for some time.

In response to the low yield environment, it seems that some are taking innovative (albeit somewhat questionable) measures. That said, an interesting investmetn vehicle has popped up in France that gives a whole new meaning to ‘alternative investing’. It seems that investors over there are turning their attention to an age old option – cow lease contracts!

Cow Lease Contracts

The process goes something like this:

Buy a couple of cows and rent them out to professional farmers for milk production. From a cost perspective, this is a plus as it helps the farmers generate cash flow and frees up money for other necessary expenditures like buildings and machinery. This type of meat market may sound extreme but promoters of cow leasing suggest that the potential yields are 4 to 5 times that being paid on savings vehicles today.

As the herd grows, each new cow represents a new source of cash flow. New offspring cover deaths in the herd, some cows are sold off to cover maintenance costs and in particularly fertile years, the return on investment for each cow can be as high as 7%. Investors can sell the new cows for cash or continue to build up their herd to then draw a regular income at retirement.

Cow Lease Risks

Although it may sound like a nifty little investment strategy, as with all investments these cash cows are not without risk. Fluctuations on the price of meat, milk and animal feed as well as unexpected disease are just some of the considerations for cow contract investors.

While environments of change often motivate innovation (did you know that Disney, FedEx, Microsoft and Apple were founded during periods of economic recession?), discipline remains the key to long-term investment success.

As dividend growth investors, we must remain confident that we are on the right track to achieving our long-term goals. Whether those ultimate investing goals are growth or income.  It also means that we won’t need to follow the herd on the latest investment fad or have to convert our houses into cattle ranches anytime soon!

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The following are three high-level economic data points that we can use, along with our other tools, to further assist us determining our views on equity market investments.

1.) U.S. Housing

As the root of the credit crisis, healing in the U.S. housing market is a precondition for sustainable recovery. Recent data has confirmed that the worst is behind us and the residential real estate market is stabilizing.

The inventory of unsold houses while still high is heading in the right direction towards clearing and sales of existing homes have recently turned positive on a year-over-year basis. And an index which measures year-over-year price changes of houses in 20 major U.S. cities (the S&P/Case-Shiller Home Price Index) plunged 33.6% from its June 2006 peak to the April 2009 trough, but has now climbed 1.9% over the past two months.

2.) The U.S. Consumer

The resurgence of the U.S. consumer will be key to watch as recovery unfolds since consumption is 70% of the American economy. Despite the ‘hit’ that the housing crisis has exacted on their net worth, American household balance sheets are still in relatively better shape than they’ve been in the past due to the tremendous growth net worth over the last decade.

However, the process of deleveraging (winding down debt) has begun and this will impact spending patterns in the near-term.

3.) The U.S. Manufacturing

The level of manufacturing has historically followed an inverse path to the Fed funds rate but on a 6-month lagged basis – as the fed funds rate drops, six months later, manufacturing activity picks up.

However, in fall 2008, although rates declined to historically low rates, the credit crunch intensified and that typical relationship between low interest rates and increased manufacturing activity did not materialize. More recently, credit channels have opened up and the ISM (gauge of manufacturing activity) has improved, indicating the economy is finally responding to massive stimulus after a long lag.

And further improvement just yesterday with the latest ISM level better than expected at 52.9 – the first reading above 50 since January 2008 and hit the highest level since June 2007. This is further indication that while not yet normal, the economic environment is normalizing.

These are three key areas of the market to watch when assessing the high-level economic situation and it’s relationship to the stock market trends and valuations.

Of course this isn’t the be all and end all of data you should include in your due diligence, but it certainly plays a role as you calculate your risk tolerance moving forward.

Here’s a summary of market action and key developments from last month, including monthly benchmarks.

• Investors saw more data indicating that healing is underway in the global economy. Increased optimism paved the way for a fifth consecutive month of gains across world markets.
• International stocks advanced. The MSCI World Index returned 8.4% (in $US terms). Since March 9th, the MSCI Asia Index has risen about 58% in local currency terms.
• Commodity prices rose. Copper is up more than 80% year-to-date supported by increased demand from China. The S&P/TSX Composite Index benefited, adding 4%. The S&P/TSX has climbed 45% since hitting a five-year low on March 9th.
• In the U.S., stocks made up more ground. The Dow Jones Industrial Average (DJIA) had its best month since 2002, up 8.6% . The S&P 500 Index advanced for the fifth consecutive month (the longest streak since 2007) gaining 7.6% . The S&P 500 is now up more than 40% since March 9th and Monday, it closed above the 1,000 level for the first time since November 2008.
• Volatility continued to be a key theme in currency markets. After falling more than 6% against the U.S. dollar in June, the Canadian dollar appreciated by 7.4% versus its U.S. counterpart in July. This cut into returns on investments denominated in $US. Case in point, the 7.4% gain on the S&P 500 was essentially wiped out when converted back to C$.

With much of the latest economic news continuing to look less bad (over 70% of companies beat expectations last quarter and it appears US housing may have found a bottom), the economy looks to be on the mend.
However, we must realize that the rate of recovery that we are seeing is not normal and likely cannot be maintained long-term. That said, as an investor looking out 5+ years I belive valuations in the equity market are still low and the potential remains for double-digit returns heading forward over a 5+ year horizon.

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1. An investor’s choice of asset allocation is the single largest factor that will influence the probability of long-term success. Historical evidence suggests that cash investments return the least amount over the long run.
2. There is significant upside potential in equities for long-term investors right now. Stock valuations are, despite Q2’s rebound, well below their highs and have a long way to go to be back in line with what we consider to be fair value.
3. Sustained low interest rates and dramatic increases in money supply combined with increased deficits have many fearful of the inflationary impact once economic recovery takes hold. Money market investments, non-market linked CD’s and high interest savings accounts offer little protection against the wealth eroding effect of inflation.

That is not to say that there is no downside.  In fact, there is an inherent risk when investing in equities.  However, I beleiive the risk vs. reward payoff  still favors the equity investor at this time.