Back around 2010, while working with Caterpillar, I had the opportunity to work as part of a “commodities pre-buy team.”
What our commodities pre-buy team analyzed
The role of our group was to:
- Determine the volume of various commodities that were used in some manner by the company.
- Identify an appropriate surrogate financial vehicle for each commodity.
- Work with treasury to identify how and when to potentially place hedge positions vis-à-vis each of these financial vehicles.
Now I’m guessing that many reading the above are going to be scratching their heads about what I just said. If not, I’m guessing that if I launched into a deeper discussion on contango and backwardation, I would lose quite a few more readers.
What “investing in commodities” actually means
At the core essence, investing in commodities involves purchasing some sort of physical good or a contract on some sort of physical good. As with any market, there is ALWAYS a buyer and a seller. If you’re buying, you believe the price is heading up. If you’re selling, you believe the price is heading down. Unless of course you are HEDGING in which case you are trying to lock in the price to protect against some exposure you have—but that’s a topic for another day. (Hedging is sometimes very wise.)
Involving yourself in commodities is gambling + It’s hard to do.
In my mind, getting involved in the commodities market is akin to betting; and, in my mind, betting is the furthest thing from investing that there is. To make things more difficult, it is NOT easy to either understand OR to purchase commodities in the market. Yes, it can be done; however, it requires quite some research to become proficient in simply understanding and using the tools. These are two of the major reasons that I am NOT a fan of investing in commodities.
Commodities do not produce explicit economic value.
The next reason has to do with what I see as a major difference between commodities and companies. Commodities do NOT produce any explicit economic value. While they HAVE value, it’s not like a bar of gold or roll of copper is going to make you a new shirt or provide you with some service. In contrast, companies DO produce goods and services, and, in so doing, produce economic value. In my opinion, when you are investing, you want to be doing so in entities that produce economic value. Again, this is a reason I generally avoid commodities.
This is not advice—but it IS a challenge.
As always, nothing that I write in my blog posts should be construed as investment advice. Only you and your advisor know the specifics of your situation. My point in writing this post is to challenge any readers about whether they really understand what commodity investing is and is not. If you do, then you may be good candidates to pursue commodity investing. Otherwise, I’m going to stick to my guns and suggest that getting involved with things that you don’t understand generally does not turn out well.
Thank you for sharing a bit of your time with us this Friday.
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