C Is For Commodities
Ok we’ve reached letter C in the Elite Investor Club A-Z of investing. Once again, an early letter in the alphabet covers a huge asset class – commodities. Commodities are physical things that we consume or metals that we use in industrial processes. Although gold is technically a commodity, I’ll be covering it separately in a later episode so here I’m going to focus on oil, gas and agricultural commodities.
These latter are essentially things that are grown or reared rather than things that are mined, so the list would include sugar, fruit, cattle, corn, soybeans, wheat and the like. A big advocate of commodities investing is Jim Rogers, the legendary investor who has now moved his family lock, stock and barrel from America to Singapore. He runs the Rogers International Commodities Index and is convinced that exposure to commodities should be a cornerstone of any sophisticated investors portfolio.
But here’s the thing. Logic would suggest that, with an ever growing population, scarcity should be driving prices up year on year. But its more complicated than that. Because the price of commodities, like anything else, is driven by supply and demand. Or, in the case of the futures market that we’ll address in a separate episode, by people’s views on where supply and demand might be going in the future. Let’s look at as an example. It seems the world was taken by surprise when the price of crude oil halved towards the end of twenty fourteen. Yet it was mainly a reaction to the new supplies coming on stream from American fracking, with the US going from decades as a net importer of oil to suddenly having millions of barrels being available for export.
Developments in agriculture have increased productivity of farmland and kept downward pressure on many of the products we consume each day. The last few years have not been kind to commodities investors. The Rogers index is down a whopping twenty six per cent in the last two years, while the more widely used CRB index has been on a downward trend since twenty eleven. Of course, sophisticated investors can make money in a down market, either through spread betting or through the futures and options markets. But this is not for the faint hearted and certainly not for beginners. My suggestion for an advanced commodities strategy is to use the approach we’ll cover in the very last episode of the A-Z, which is the Zulu principle. In other words, focus on a single commodity and become an expert in it. Let’s say you choose sugar. Read up on everything you can that impacts the sugar price in the global economy. When does information about harvests become available?
What are prices in the futures market telling you? Once you’ve educated yourself you can form a view on where prices are heading and choose the most suitable vehicle to back your hunch. You can start with paper trades but my own view is that they teach you little other than the mechanics of the process. What really matters is how you manage your emotions and the discipline you apply in limiting your losses when you get it wrong. I wouldn’t even dream of trading in this way unless you’ve had some training from people like Marcus de Maria or Siam Kidd.
Fortunes have been made and lost in the commodities market, so make sure you start small, set stop losses and only risk a fraction of your portfolio in the volatile world of commodity futures.