The High Income Factor

Conquer the Commodities Boom

4 Powerful Income-Paying Natural Resource Plays

A Moneynews.com Special Report

by Tom Hutchinson

2 TheHighIncomeFactor.com Special Report

The average home in America is 2,100 square feet. What most people don’t realize,

however, is how many and varied raw materials it takes to make a home.

For example, it contains 439 pounds of copper and more than 200 pounds of steel. The process of making and refining these metals took more than a dozen gallons of oil.

In short, even something as basic as an empty home couldn’t exist without commodities.

But that’s not all. A car in the garage will use a few more hundred pounds of steel, nearly an ounce of palladium, and will need gas to run on. Appliances in the home will add a few more hundred pounds of copper.

That home will use 936 kilowatt-hours of electricity each month on average, according to the Energy Information Administration. That power will be generated from oil, natural gas, coal, or uranium.

Like it or not, it’s inescapable to live in a society without using many commodities.

While everyone has an investment in commodities, most investors still shy away from commodities as an investment.

In this report, I’ll explain what commodities are, why they make sense as an investment, and how you can generate income off these necessary raw materials.

Commodities ExplainedCommodities are physical assets and raw

materials such as minerals, grains, metals, livestock, and oil. You’ve probably heard a lot about commodities on the news in recent years. A main reason for the notoriety is that they have been tremendously successful investments over the past decade. And the strong returns are likely to continue.

The primary driving force behind the commodity boom can be summed up in two simple words: emerging markets.

As emerging markets such as China, India, and Brazil have burst on to the world economic stage in the past decade, demand for industrial raw materials and other commodities has exploded.

In the past, commodity investing involved the purchase of the physical metal, food, or livestock. That’s why investment legend Warren Buffett derided gold as an investment. Outside the use for jewelry and electronic components, there’s very little practical use for the metal. Most of the gold ever mined sits in bank vaults in bar form.

Commodity investments typically weren’t right for average investors because they lacked a very important feature — an income. Indeed, it costs money to store and transport these items.

In years past, income investors would have to look on with envy as commodity prices

150140130120110100908070605040302010

1/00 1/2002 1/2004 1/2006 1/2008 1/2010 1/12

Monthy historical spot price

O 2010 A J O 2011 A J

750^0

687^4

625^0

562^4

500^0

437^4

375^0

312^4

Source: Supercharts by Omega Research

Source: Yahoo! Inc.

Crude oil went from less than $20 per barrel in 2000 to $145 by 2008:

Crude oil went from less than $20 per barrel in 2000 to $145 by 2008:

Spot Oil Price: West Texas Intermediate - 10 Year Chart

Price of a Bushel of Corn 2010-Present

Special Report Moneynews.com 3

soared. That’s because commodity investments have typically focused on futures trading in the spot market. These markets required substantial income as well as investor savvy to profit from minute changes in the market. It definitely wasn’t the kind of place for small investors to safely put their money to work.

However, as markets and investment vehicles continue to grow in sophistication, more and more commodity-oriented company stocks and funds are paying dividends.

Also, investments like master limited partnerships and real estate investment trusts that are specifically designed to pay a high income have become available to individual

investors. An explosion of closed-end funds that invest in commodities and commodity-producing companies also have grown.

In short, the epic rise in commodities is not just for a boon for speculators anymore. Income investors can participate, as well. We’ll take a look at the tremendous opportunity in commodities for income investors. But first, let’s look at what has been behind

the commodity boom and, more important, where commodity prices are likely to go from here.

The Main Drivers of the BoomSupply and Demand

As economics 101 dictates, when demand for a good or service increases relative to supply, prices generally go up. Such has been the case for most commodities as emerging markets have dramatically grown productivity over the past decade, increasing demand for assets in finite supply.

How much have China and other emerging markets changed the landscape? In the past decade, world trade has exploded to a level far beyond what the world has ever known. The global exchange of goods increased nearly 80 percent just between 2005 and 2008, according to the World Trade Organization.

Twenty years ago, China was a tiny player, essentially irrelevant to the global economy. Now the country is an economic behemoth that consumes a staggering 40 percent of the world’s metal supply, according to the World Bank. The World Bank also estimates that emerging markets now consume about one half of the world’s oil production, up from 25 percent in 1970.

Not only did demand for commodities explode, but it also did so against a backdrop of a commodity supply infrastructure that hadn’t accounted for it. In other words, worldwide

4.6000

4.4000

4.2000

4.0000

3.8000

3.6000

3.4000

3.2000

3.0000

2.8000

O 2010 A J O 2011 A J

Copper has more than tripled in price since the end of 2008:

Source: Supercharts by Omega Research

Spot Copper Prices 2009-Present

2006 2007 Apr Jul Oct 2008 Apr Jul Oct 2009 Apr Jul Oct 2010 Apr Jul Oct 2011 Apr Jul

180

160

140

120

100

80

60

GLD

Source: Yahoo! Inc.

Spot gold Prices 2006- Present

Gold has more than tripled in the last five years:

4 TheHighIncomeFactor.com Special Report

mining operations and oil drilling did not expand on a pace with emerging-market growth.

The effect of increased global industrial production on commodity prices is illustrated in the following chart:

Inflation and the Value of the U.S. DollarIncreased demand hasn’t been the only

factor driving prices higher. Commodities are priced in U.S. dollars. As the U.S. dollar falls in value relative to other currencies, it takes more dollars to buy the same amount of “stuff.”

Over the past 10 years, because of escalating deficits and the Federal Reserve System’s low interest rate, among other things, the dollar has been in decline. Since 2002, the U.S. Dollar Index (an index of the U.S. dollar versus a basket of major world currencies) lost more than 37 percent of its value. The dollar has declined 8.5 percent in just the past year alone!

Commodities: Bright Future AheadCommodity prices have no doubt soared

over the past decade. But where do they go from here? Is the party over? Are we witnessing a commodity bubble similar to the real estate bubble of the last decade, or are we still in the middle of a global financial dynamic that will continue to drive prices higher?

In the short term, commodity prices can be quite volatile and unpredictable. However, over the longer term, I believe the fundamentals are in place to continue to drive most commodity prices higher.

But there are two factors to consider.Volatility

The thing about commodity prices is that they can be quite volatile. Even within the incredible boom of the past decade, commodities experienced a terrible crash.

The CRB Continuous Commodity Index (a broad group of 17 different commodities that is considered a benchmark in the asset class) fell by a whopping 50 percent in just five months between July and December 2008 in the middle of the financial crisis. Crude oil prices fell from $147 per barrel to $34 in the same short period.

Commodities are cyclical, especially in the short term. As the world eonomy came crashing down during the financial crisis, so did the demand for many commodities. However, as panic waned and economies (especially in emerging markets) recovered, commodities have come back strong. In fact, the CRB

index is higher than it was at the peak before the financial crisis, as are several individual commodities.

The financial crisis is an extreme example of commodity price volatility, but it does underscore the risk to commodity investing in the short term. Recently, commodity prices have come down from the highs earlier this year as fears regarding the European debt crisis and a possible double-dip recession in the United States have gripped investors.

In the short term, the prices of commodity investments will be highly dependent on the economy. If things continue to worsen, prices will fall. If things pick up from here, they will

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

125.00120.00115.00110.00105.00100.0095.0090.0085.0080.0075.0470.0065.00

Source: Barchart.com

$DXY - Dollar Index (INDEX) - Monthly OHLC Chart

Source: Netherlands Bureau for Economic Policy Analysis and CRB

00 01 02 03 04 05 06 07 08 09 10 11

300

275

250

225

200

175

150

125

100

75

145

140

135

130

125

120

115

110

105

100

95

Index (2000=100) Index (2000=100)

Wor

ld In

dust

rial

Pro

ducti

on

Non-energy com

modity prices

Commodity Prices Track World DemandWorld Industrial Production and Commodity Price

Special Report Moneynews.com 5

likely rise. But fundamentals should drive prices higher over the longer term.

Emerging markets, which account for a huge share of commodity demand, are still in the process of rapidly growing. These high-growth rates should continue for years and, as these economies grow, so will their demand for commodities. But there is another powerful trend looming — inflation.Inflation

Skyrocketing debt and deficits should drive inflation higher over time. The situation is quite grave. U.S. debt is about $14.5 trillion and rapidly growing, up from $9 trillion in 2008. To put the debt crisis in perspective, the $5.5 trillion in debt acquired in just the last two and a half years represents 56 percent of the debt accumulated from our founding in 1776 until 2008.

As the deficit explodes, it becomes increasingly difficult to make payments without the allure of simply printing the difference

As the Fed continues to print money ($2.5 trillion alone on quantitative easing and QE2), the dollar has fallen to a postwar low.

All that newly printed money and extra dollars will be chasing the same goods in the years ahead, possibly driving prices higher at an astounding clip.

As hard assets, unlike paper currency, commodities tend to maintain their value and increase in price during times of rising prices. Commodity investments provide an excellent defense — or hedge — during times of inflation.

In fact, when the consumer price index increased from 3 percent in May 1972 to 11 percent in December 1974, the S&P Goldman Sachs Commodity Index rose 222 percent, a 55 percent average annual gain!

During the high inflation/high interest rate period of 1972 to 1981, commodities averaged 19.16 percent per year while bonds averaged just 3.27 percent. After taxes and inflation, the bond return was negative.

Why Income Investors Need Commodities

Most investors understand the importance

of income. A regular cash payment that can be spent or reinvested offers tremendous opportunities for investors. Income investors would be wise to add commodity positions to their portfolios because such diversification offers tremendous opportunities, such as:

Rising profits and dividends Rising profits from rising commodity prices mean rising dividends. The best place to invest is where there is growth. In order to secure a stable and growing income stream, income investors need exposure to this asset class.

A hedge Inflation is a terrible thing. It erodes the value of savings by diminishing the amount of goods and services the same number of dollars can buy. Investors need to defend against this by gaining exposure to an asset class that will at least maintain its buying power during inflation. Also, times of inflation are often accompanied by rising interest rates. Rising interest rates kill fixed-income investments. The value of bonds tends to fall because the fixed yield declines relative to new rates available in a rising rate environment. For this reason, income investors are typically the hardest hit by inflation. By investing some assets in commodity investments, fixed-income investors get a much-needed hedge against other fixed-income investments, which probably represent most of their other holdings. Given the strong potential for profits over the longer term, as well as the defense against inflation and rising interest rates, commodities are something that today’s income investors simply can’t ignore.

Where to Find Income From Commodities

Although many investments offer exposure to commodities as well as a modest yield, several investment structures exist beyond the common stock structure that does far more. These structures offer higher yields on investments related to commodities, and they can provide

6 TheHighIncomeFactor.com Special Report

tax benefits, too.Master Limited Partnerships (MLPs)

MLPs are great investments for two basic reasons: tax benefits and superior business plans.

Granted certain tax incentives in order to encourage exploration and investment in natural resources, MLPs pay no income taxes at the corporate level provided that they pay out the bulk of earnings to unit holders in the form of distributions. This gives MLPs a huge advantage over corporations, which pay 35 percent of profits in taxes. In essence, MLPs are able to beef up distributions with money that ordinary corporations lose to taxes. Money goes in your pocket instead of Uncle Sam’s.

Plus, you typically don’t get killed on taxes from MLP income, either. Most MLP distributions are composed of about 20 percent ordinary income, taxed at regular income tax rates, and 80 percent return of capital, which is taxed at the much lower capital gains rate when the security is sold.

While MLPs can include companies involved in shipping, real estate, and finance, most MLPs operate in the energy arena. The majority make money by owning oil and gas pipelines and processing facilities.

But they’re not overexposed to volatile oil and gas prices because they earn most of their income by simply charging a fee for piping and storage. They essentially act as toll roads — receiving a fee based on the amount of volume shipped via their network.

The solid fee-based revenue streams have enabled many MLPs to pay consistently rising distributions. For example, Magellan Midstream Partners (NYSE: MMP), a huge player in the piping of refined petroleum products, now pays a quarterly distribution that’s more than five times that of its first distribution in 2001.

Kinder Morgan Energy Partners (NYSE: KMP), one of the largest energy storage and transportation limited partnerships, has grown its quarterly distributions from $0.16 per share in 1995 to $1.15 in 2011.

Many MLPs are publically traded and listed on major exchanges and can be bought and sold on any business day just like a stock.

Real Estate Investment Trusts (REITs)Although not always considered a traditional

commodity, real estate is essentially a hard asset that maintains its value during inflation. A REIT is a tax designation for a corporate entity that invests in a portfolio of real estate properties or mortgages. These properties generate income and REITs, like MLPs, enjoy a special tax designation by which they pay no taxes at the corporate level provided that 90 percent of income is paid to unit holders in the form of dividends.

Although REITs can invest in commercial or residential properties as well as mortgage securities, according to National Association of REITs, 84 percent of the 134 publicly traded U.S. REITs own and most often manage commercial real estate. These REITs derive most of their income and distributions from rents.

Unlike most commodities, most real estate prices haven’t sprung back with a vengeance after the financial crisis. After all, the bursting of the real estate bubble and the subsequent subprime mortgage debacle is what caused the financial crisis. Housing prices have still not recovered and are in fact setting new lows.

Most rational people would naturally be skeptical about an investment in real estate at this point in time, as it was the bursting of the housing bubble that led to our current trouble. However, REITs have been surprisingly solid performers since the financial crisis.

Yes, REITs took a beating during the financial crisis (what didn’t?). The FTSE NAREIT All REIT Index (an industry benchmark) returned -18 percent in 2007 and then lost an additional -37 percent in 2008.

However, the index has since posted solid returns in 2009 and 2010 of +27 percent in each year and has positive returns so far this year. The index also yields a solid 3.55 percent, but many individual REITs are paying much more. For the most part, falling real estate values have been absorbed in the prices and many REITs have solid tenants that continue to pay rent. And, from here, real estate price are hardly overinflated.Closed-End Funds

Special Report Moneynews.com 7

Closed-end funds offer some huge advantages to income investors. First, you own a share of a vast portfolio of companies, providing a level of safety through diversification that you won’t get by owning one or even a handful of companies. Second, funds have the resources and expertise to search every corner of the globe for the best opportunities. And finally, they often pay monthly rather than quarterly income.

In just a quick screening of closed-end funds in the commodity/energy/real estate arenas, I found 29 funds currently paying a yield of 6 percent or higher, with some paying close to 10 percent.

Here are a couple examples:• The Gabelli Global Gold, Natural

Resources & Income Trust (NYSE: GGN) is a closed-end fund that pays a high monthly income by investing at least 80 percent of the fund’s assets in equity securities of companies involved in the gold industry and the natural-resources industry.

As of March 31, 2011, the fund was invested 51 percent in metals and mining and 45 percent in energy and energy services. Top holdings included Canadian-based gold and silver miner Agnico-Eagle Mines Ltd. (NYSE: AEM), Canadian oil and gas giant Suncor Energy Inc. (NYSE: SU), and gold-mining giant Newmont Mining Corp. (NYSE: NEM). The fund pays consistent $0.14 monthly distributions and currently yields a whopping 9.7 percent.

• Kayne Anderson Energy Total Return Fund (NYSE: KYE) invests in stocks and bonds of companies in the energy industry, including MLPs and Canadian energy royalty trusts. The portfolio on June 30, 2011 consisted of 46 percent MLPs, 16 percent shippers, and 15 percent U.S. and Canadian income trusts.

The fund seeks total return with an emphasis on high income and currently pays a stellar 7.7 percent yield. KYE has returned investors (with reinvested dividends) more than 90 percent since its inception in 2005.

Stocks of Individual Commodity Companies

Common stocks represent fractional ownership of an ongoing business. Commodity companies typically focus on acquiring, exploring, and developing new commodity resources. While many small-cap commodity companies may focus on finding new commodities to exploit, large, developed commodity companies with production and refining typically have enough free cash flow to pay a dividend to shareholders. Here are some of the top income-producing commodity companies:• BHP Billiton Ltd. (NYSE: BHP) is the

world’s largest publicly traded mining conglomerate. The Australia-based company supplies a diversified array of natural resources, including aluminum, coal, copper, iron ore, mineral sands, oil, gas, nickel, diamonds, uranium, and silver primarily for industrial production

This natural-resource giant sells raw material all over the world by primarily in its own backyard — China and Asia. The company is perfectly positioned to feed the fastest-growing economies and should profit mightily in the years ahead.

BHP pays a 2.70 percent yield and has grown the dividend at an average annual rate of 25 percent per year since 2002. The stock has returned an amazing average annual return of 25 percent per year for the past 10 years and is selling 23 percent down from its 52-week high.

• ExxonMobil Corp. (NYSE: XOM) is the largest publicly traded company in America and the world’s largest public oil and gas company. The company explores, produces, and refines oil and gas all over the world. It operates facilities or markets products in most of the world’s countries, searches for energy on six continents, and is the world’s largest refiner.

The company has production projects in virtually every corner of the world and generated more than $380 billion in revenue in 2010. The company’s size gives it economies of scale that enable it to win

8 TheHighIncomeFactor.com Special Report

business and operate profitably. In addition to being geographically diversified, Exxon has a diverse product mix in oil, natural gas, and clean energy.

Exxon pays a 2.6 percent yield now on a dividend that has been consistently growing since the mid-1970s. It has been a consistent performer, returning an average of 10 percent per year for the past 15 years, and is big and diverse enough to weather any bumps in the road in a volatile industry.

• Monsanto Co. (NYSE: MON) is a St. Louis-based agricultural products maker and the world’s leading producer of seeds for corn, soybean, cotton, fruits, vegetables, and other crops. The company genetically engineers seeds that produce more bountiful crops and produces herbicides that protect crops against bugs and weeds.

The company is a heavyweight in one of the best industries to be in at this point in history — food. The World Bank estimates that worldwide demand for food will increase 50 percent by 2030. As the world struggles to find ways to feed itself, Monsanto will be a primary beneficiary.

While Monsanto only pays 1.9 percent now, the dividend has more than quadrupled over the past decade.

Top Stock Pick:Southern Copper Corp. (NYSE: SCCO)

is one of the largest copper producers in the world with revenues of $5.1 billion in 2010. The Arizona-based miner operates mines in Peru, Mexico, and Chile and is 80 percent owned by Mexican conglomerate Grupo Mexico. The company primarily produces copper (77 percent production in first half of 2011) but also mines molybdenum, zinc, lead, coal, and silver.

What’s so good about copper?Copper is one of the world’s most important

industrial metals. It is used for electrical equipment as well as water pipes, data cables, automobile radiators, cooling and refrigeration, and heat exchangers, just to name a few.

With the rapid growth and industrialization of emerging markets such as China and India,

demand for this very practical metal has absolutely skyrocketed. Between 1998 and 2008, worldwide copper demand increased 34 percent, according to the International Copper Study Group. Most of this rising demand has been from China, which now accounts for 37 percent of worldwide copper demand. Asia accounts for more than 60 percent.

While demand is rising, copper is a finite resource and the growth in supply has not kept pace. Demand over the past 10 years has outstripped supply and is projected to continue to do so. The effect on price has been astounding. Copper prices have gone from $0.75 per pound in 2003 to more than $4 today. According to Morningstar, an investment in copper would have provided an average annual return of 32 percent per year for the last 10 years.

Looking forward, the ICSG forecasts global demand for copper to exceed supply by 250,000 metric tons. There are other large copper producers, including BHP Billiton Ltd. (NYSE: BHP) and Freeport McMoRan Copper & Gold Inc. (NYSE: FCX), but Southern Copper has several key advantages over competitors:

World’s largest copper reservesSouthern Copper at its Mexican and

Peruvian mines is estimated to have the largest copper reserves in the world, a massive long-lived reserve base of 60 million tons. The miner will have the ability to ramp up production and increase sales. In fact, the company has targeted copper production increases from 630,000 tons in 2011 to 1 million tons in 2015.Lowest cost producer

SCCO’s unmatched portfolio of highly desired open-pit mines makes it the lowest cost producer of copper in the world, at $1.67 per pound in the first half of 2011. Low costs equal high margins and profitability. The company has a trailing 12-month profit margin of 32 percent and return on equity of more than 50 percent.Huge dividend

The company pays a quarterly dividend

Special Report Moneynews.com 9

in March, May, August and November. These dividends vary with earnings, which has been a good thing because earnings have risen steadily since the financial crisis. The latest quarterly dividend of $0.62 per share is up from $0.10 in the same quarter of 2009. Dividends over the past four quarters have totaled $2.19 for a trailing yield of 7 percent at today’s price ($2.16/$31.34). However, the latest dividend of $0.62 translates to a 7.6 percent yield.

Earnings have been stellar. Second-quarter sales increased from the year ago period by 54 percent to $1.8 billion, and operating income was up 84 percent over the same period to about $1 billion. The company also has a rock-solid balance sheet with a debt/equity ratio of 68 percent and about $1.4 billion in cash at the end of the second quarter. However, SCCO is all the way down to $31 from a high of $50 at the beginning of the year.

While the long-term supply-and-demand dynamics for copper look solid, the near term is less certain. Danger looms as Europe’s debt crisis seems to be getting worse and the United States flirts with the possibility of a double-dip recession. However, these risks are already largely reflected in the price. While there could still be price pressure in the months ahead, the current price is a good entry point for longer-term investors.

ConclusionWhile commodities may not have been part of your income portfolio

in the past, the world is changing fast. Strong fundamentals are well in place that will make commodities strong investments for years to come. The right investment can benefit you mightily in the effort to grow wealth and secure a robust income.

Not only is investing in commodities exciting, but it’s also defensive. As an investor, you simply can’t ignore the eroding dollar and the prospect for high inflation and interest rates in the not-too-distant future. Commodity income investments offer the potential for solid appreciation as well as a hedge that investors should not be without.

© 2012 The High Income Factor. All Rights Reserved. The High Income Factor is a monthly publication of Newsmax Media, Inc., and Newsmax.com. It is published for $99 per year and is offered online and in print through Newsmax.com and Moneynews.com.

For rights and permissions, contact the publisher at P.O. Box 20989, West Palm Beach, Florida 33416. To contact The High Income Factor, send e-mail to: customerservice@newsmax.com. Subscription/Customer Service contact (888) 766-7542 or customerservice@newsmax.com. Send e-mail address changes to customerservice@newsmax.com.

Chief Executive Officer CHrISTOPHEr ruDDY

Financial Publisher AArON DeHOOg

Senior Financial Editor TOM HuTCHINSON

Editor ANDrEW PACKEr

Art/Production Director ELIzABETH DOLE

DISCLAIMEr: The owner, publisher, and editor are not responsible for errors and omissions. This publication is intended solely for information purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or sell or trade in any commodities or securities herein named. Information is obtained from sources believed to be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted. In no event should the content of this market letter be construed as an express or implied promise, guarantee, or implication by or from The High Income Factor, or any of its officers, directors, employees, affiliates, or other agents that you will profit or that losses can or will be limited in any manner whatsoever. Some recommended trades may involve securities held by our officers, affiliates, editors, writers, or employees, and investment decisions may be inconsistent with or even contradictory to the discussion or recommendation in The High Income Factor. Past results are no indication of future performance. All investments are subject to risk, which should be considered before making any investment decisions. Consult your personal investment advisers before making an investment decision. Please view our Terms of Use for full disclosure at www.newsmax.com/terms.html. Copyright © 2012 The High Income Factor.

TheHigh Income Factor

About Tom Hutchinson

I’ve worked in finance my entire career, from the back office of a Wall Street firm to the floor of the New York Mercantile Exchange learning how markets work. Eventually, I became a financial adviser where I met with thousands of investors and managed the portfolio of hundreds over the course of about 15 years.

I left my career as a financial adviser, writing for The Motley Fool as well as Street Authority LLC, researching companies, industries, and markets.

In The High Income Factor, I can bring you the full benefit of my years of investing experience.