As I mentioned in this post, I got rid of DBB – the base metals ETF. Admittedly, I’m hanging my head in shame – not because we lost money (actually, we made money) but because I made a stupid judgment mistake that cost us opportunity. (Fortunately, there’s a lesson in here.)
My mistake was not in my evaluation of the commodities or reasoning for buying them. The mistake was that I bought an investment that grouped the three together instead of buying a virtual certainty.
In buying DBB, I decided that the three base metals in DBB – copper, zinc, and aluminum – would all move more or less together. Producers were scaling back and still the prices of these commodities crashed. I figured that, when the world realized it wasn’t coming to an end, all three of these would move back up together.
Well…I was wrong.
Copper did exactly what I expected; zinc started its run up; aluminum disappointed. If I had held these commodities individually, I would have sold copper, held aluminum, and considered dumping zinc. Instead, I bought them together and had a “group” decision.
My Dilemma
With copper at a fair price, I had a choice – hang on to DBB and hope that zinc and aluminum returned to more rational levels, all while hoping that copper bubbled up or, at the very least, didn’t fall much, or sell.
Personally, I don’t think that hope is a very intelligent investment strategy; so, I sold.
My “Whoops” Cost Us Opportunity
On April 4th, we bought the three commodities together through DBB. We earned roughly 11.6% in two months – a great return in and of itself. Here’s where I screwed up: in the absence of a pure aluminum or pure zinc ETF, I bought them together with copper through DBB. (I could have purchased a pure copper ETF in JJC.) Instead of buying just JJC, knowing that copper was cheap and that it would move up at some point, I bought the three metals knowing they were cheap and that they would move up at some point. Unfortunately, I tried to get greedy, they didn’t all move up together at the same pace, and we missed an opportunity.
What was the real opportunity cost? If I had not gotten creative and simply purchased the copper ETF, accepting that I would miss the boat on aluminum and zinc, we would have earned JJC’s 17.7% return.
The Base Metals Lesson
Considering the markets over the past two years, it’s odd that someone might say, “Well, we made money, but here’s where we screwed up.” Still…we made money, but here’s where we screwed up:
Creative is stupid. (Just ask the folks at Lehman, AIG, Merrill, Bear Stearns, etc.)
When you have a great idea, you should zero in and make meaningful bets. Keep it simple and don’t allow too many variables into the equation. And that’s one main premise of the book – bet on virtual certainties.
The virtual certainty was that copper, aluminum, and zinc would all rise in price. The variable that I introduced into the equation was that they’d all rise contemporaneously.
And that cost us an opportunity.
Good Ideas are Rare. Bet Big, but Bet Smart.
Good investment ideas are rare. I’d be ecstatic to find one a quarter. In this quarterly or annual search for a great investment opportunity, you’ll make some bonehead moves. Sometimes you’ll lose money. That sucks, but you can always make more back.
It’s the lost opportunities that can kill your returns.
With DBB, I can fall back on Buffett’s “I would rather be vaguely right than precisely wrong” and sleep peacefully tonight. Still, the next time you see prices out of whack, stick to the simple investment that is virtually certain to work out well with as few variables as possible and maybe you won’t have to admit to the world that you’re a bonehead too.
Filed under: Investing in Commodities
Let me preface my comments by saying that I know little to nothing about commodities…
The way I see it, commodities like aluminum, copper, and zinc have value because they are inputs in the production of goods as varied as airplanes, packaging, cans, batteries, and medicine. A company that produces drink cans needs a certain amount of aluminum, and has to pay enough for that aluminum so that the aluminum miners can justify their work, and so on. So for that type of commodity, while I think it is extremely difficult to truly know the world-wide level of supply and the level and demand and be able to compare them to find out what the commodity should exactly be worth at that time, I agree that there is an intrinsic value involved in these type of commodities (however difficult it may be to find), and therefore can potentially be bought at a discount to that value (which is what value investing is all about).
On the other hand, many of the well known value investing hedge funds is allocating a large amount of funds to ‘investments’ relating to gold. To me, investing in gold is not value investing at all. It is so clearly a “greater fool” investment- in which the investment’s success is not based on fundamentals, but rather is contingent upon the sale of it to another guy for more money. People say that gold is a strong inflation hedge, but again I do not see the logic. I can think of much better ways to hedge inflation than buying gold.
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Joe,
It takes guts to admit when you are wrong, especially in public.
In hindsight, taking just copper out of these three metals would have been ideal (so would MSFT IPO shares). But, it seems like you were pretty quick to pull the trigger in this case simply b/c the prices of the other two metals didn’t move up right away (we’re only talking a shade over 60 days here). Are you saying that you are likely to select individual commodities in the future? If so, a narrower bet should probably equal a bigger price/value discrepancy? It seems with a basket you can be at least ‘roughly right’ versus ‘precisely wrong’.
Also, if you are willing to go long on commodities, based on supply and demand observations, does that mean that you would short them (based on the same criteria) as well?
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mark: There is a search link on the right under Feeling Lost? Try These! Or you can access it with this link.
Adam Davis: I personally wouldn’t short commodities. For me, shorting is a strategy when you know that something is going to zero, even if you don’t know when. GM was an obvious short in my opinion – there was no chance of recovery and it was about as close to a guaranteed zero as possible. I personally would never short a stock or commodity merely because I thought that there should be a price correction because a lot could happen that would upset your position. Say you short oil at $140, but a massive war upsets supply in a major way. All of the sudden, you’re short on a commodity that, though overpriced based on “normal” levels, is suddenly temporarily cheap due to a major supply/demand imbalance. Too “gambly” for my blood.
Ryan: In my opinion, leverage is not a strategy; it’s a tool to be used sparingly and for temporary purposes. With a double- or triple-levered investment, you could make huge gains…or lose everything – fast. In my opinion, putting enough of one’s portfolio into a great idea usually works out just fine.
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I hope a new post is coming this weekend.
Hello Joe,
Quick question: What is your method for calculating maintenance capital expenditure.
I understand this is a hard figure to come to, and many places say you can just take Depreciation Amortization to = maintenance cap ex.
How is this so? What is the logic for D&A (the allocation of past costs to future years) to be similar to the money required to keep the business going at the current rate.
Thanks
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Joe brings up a very good point about investing: The investing process is simple to understand but challenging to execute. It is a two step process: The first step is to distill your ideas down to your very best ideas that are executable. The second step of the process is to find the vehicle that will deliver on those goals.
When analyzing the vehicle you need to do what a mechanic would do when evaluating a car, look under the hood. That is where the true investing process comes to life. This process is exactly the same whether investing in a business or investing in ETF%u2019s. Investing in commodity ETF%u2019s has the additional challenge of knowing how the ETF will track the underline. Not all ETF%u2019s are created the same and in fact, as many people have learned the hard way with the leveraged ETF%u2019s, they don%u2019t always track the underline. There are numerous oil ETFs/ETNs: OIL, USO, USL, DXO, DTO, OLO, SZO, DBO, DOY, UOY just to name a few. Now that you have solidified your idea to go long oil, the challenge is to find the best vehicle to get you from point A to point B. It is a lot like a horse race: knowing which horse to bet on is sometime more important then knowing who will win the race.
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