This whole discussion underscores the importance of staying within one’s circle of confidence and competence. Thanks all for contributing!

You can’t say “There is no way of knowing what that bag is worth of”. If the commodities investing is out of your circle of competence, you should stay away from that. Some intelligent people thinks that they understood supply & demand and there are mispricing & bet accordingly.

Certain percentage of companies in the world produce those commodities. Their profitability is based on the prices of those commodities. No company is profitable at some dumb commodities prices. So, in your case you wont be able to value those companies as well. But you cant really say those who make investments in these companies are speculative investments.

This article is just to outline the various types of investments & increase the circle of competence of people who are into investing.

Just my thoughts,

Gopinath

With a good investment you should be able to read the future.

There is no way of knowing that this bag of commodities will be worth more in the future.

cheers

JC: “If the supply of a commodity is falling and demand is rising, the price will rise.”

The important element that is missing from that statement is notion of whether a commodity is overvalued or undervalued. Commodity prices can decline even if demand rises while supply falls. Seems impossible?

Consider oil prices from 1980 to 2000. Except for a brief decline in the early 80′s, world oil demand actually kept going up all throughout the 80′s and 90′s. Yet, oil prices actually declined in that period. I think production did go up here and there but that can’t explain the huge decline in oil prices from the 70′s to the 2000′s.

The real reason, of course, was that oil was overvalued back in the late 70′s/early 80′s. Supply and demand fundamentals could be bullish but if the commodity is overvalued, it will fall; and vice versa.

I’m not a value investor but one of the reasons many value investors avoid commodities is because it’s difficult to price it. How do you figure out what the price of a commodity should be? Should oil be $30? $50? $70? $100? $200? $500? How about copper? Is $2 too high? Is $1 too low? Is $0.50 right? Even if demand is greater than supply, how would one know whether the price should go up 25% rather than 5% or 50%?

I’m (mildly) bearish on commodities but there is nothing wrong with investing in them but they are a totally different game.

Also, I do understand the economics of supply and demand. But I also understand options and futures and that they are a risk transference tool. It’s a zero sum game, one person’s gain equally offsets the other’s loss. Unlike owning a piece of a business which produces value-added outputs, owning a commodity is a speculative bet on price movements. I’m not saying you can’t make an informed bet by doing your homework first, but it’s still a bet. Just like a professional poker player may have better knowledge than an amateur, he’s still placing a bet.

At least when buying a stock, you can build in a margin of safety. That option’s not there when purchasing a commodity.

Nice post Joe, awesome discussion too btw

I recommend you read Jim Rogers. Your statement comes from a very uninformed place. You clearly do not understand how commodities work and assume that volatility and risk are one in the same.

If the supply of a commodity is falling and demand is rising, the price will rise. As Joe elegantly said…its simple economics and NOT “pure speculation.” It is only “pure speculation” if you buy or sell commodities without knowing what you are doing. I wouldn’t recommend it for you until you learn more about them.

Buffett has also invested in commodities in the past. Look up his various silver investments and currency plays. These weren’t “pure speculation” but based on supply and demand and/or government actions or omissions that would cause one to rise or fall.

“…just realize what you’re getting into.” Commodities, like stocks, are only speculative if you are uninformed or if you are trying to trade in the short-term.

Please don’t take this as criticism. I’m just respectfully disagreeing with you.

Also, plain and simple a retail investor that purchases a commodity ETF is speculating. Someone who values a commodity-based business and determines it is trading a discount is buying a piece of a business at a fair price. A lot of commodity ETFs purchase futures or option contracts. In these deals one party is hedging risk (the business that wants to lock in prices to reduce earnings volatility) and the counterparty is accepting that risk as a speculative bet on which way commodity prices are headed. As I assume most retail investors aren’t actually in the business of buying/selling commodities to produce value-added product, they’re speculators.

I also feel that this site is losing its way and slowly becoming another blog chasing high returns rather then investing in sound businesses trading at discounts to fair value, suitable for long-term holdings. A lot of people here are clearly Joe disciples and I just caution you to realize that placing 10% of your portfolio in commodities is pure speculation and while there is nothing wrong with doing that, just realize what you’re getting into.

I think Buffett was mostly doing NCAV and risk arbitrage with his partnerships. When those opportunities dried up, he closed up shop. It may look like he’s making macro calls, but i think that’s just a testament to how the availability of NCAV stocks are a good proxy for how under/overvalued the market is overall. (There are currently tons of NCAV stocks).

More recently, I agree that he has a more complex, multifactor approach to investing, perhaps best described in Charlie Mungers “The Art of Stock Picking.” This article is a great read, but I think there is great danger in underestimating the amount of work, insight and persistance that this more vague and intuitive approach would require.