oil pump


I’ll tell you upfront, I’m not a big fan of commodities. In fact, I really don’t understand why there is such a huge buzz around Gold and Oil. If I have the choice between investing in commodities (through ETFs for example) or in companies in this sector, I’ll definitely choose the latter. Here’s why:


Most of the price of commodities are based on speculation


There are problems in Libya; the oil barrel jumps by $10. There is an economic crunch (2008); the Oil barrel loses 60% of its value. My question is; does it really cost more or less to produce gasoline today than a month ago?


Some will answer that if there are more problems in oil producing countries, it will automatically slow down production. Following supply & demand theory, oil prices will then go up. I agree with that. However, the price movements are strongly influenced by speculators and hedge funds that will make the price swings faster & harder than Milos Raonic’s serve (151mph!).


Gold doesn’t produce any benefits, companies do


Take a bar of gold and put it on your kitchen table. Wait a day. Then, since nothing happened, put it near a window (maybe it needs some light). Wait another day. Nothing. Nothing will come out of the gold bar; no goods, no dollars, nothing.


However, look at a gold producer; day after day, it will generate goods (gold products) and dollars. If the management team is competent, they will generate profits. And if their financial team is even more competent they will be able to benefit from the speculators through forward contracts (such as when Barrick Gold bought back their contracts 2 years ago betting on a higher price for gold…nice move!).


There is something behind a company


When you consider commodity related stocks, their value will obviously be influenced by the relative commodity price. For example, I was confident that the economy was coming back and that it will put some pressure on the price of oil. This is why I bought HSE and CVX at the beginning of the year.  I was somewhat lucky and there was a good oil price jump due to uncertainty in Libya. Both stocks have climbed by almost 10%.


I could have bought oil ETFs to get the same results (or better!). However, I know that there are employees working, goods produced and money generated by the companies I bought. This is how I think I will make money; because these companies will benefit from a high oil price to generate more profit. There is nothing behind a barrel of oil…but the company producing it!



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13 Comments   |  

13 Comments

March 10, 2011, 2:40 am

Simply enjoyed reading your precise blog,Mike.The trust you have in the humans (Companies) is a valid point rather than trusting the material (Commodity). The gold bar example is so appropriate to prove that commodities are a passive assets and companies are bound to get a profit with proper risk management.

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March 12, 2011, 9:33 am

Great article, couldn’t agree with you more. Investing in a company merely because it is in a sector or commodity is dumb. A company needs to stand on its own merits.

March 12, 2011, 6:30 pm

Great article! I love the comments about gold…put it near a window! Commodity based companies are usually cyclical..it’s all about trying to purchase on the downside of the cycle. I wish I would have purchased more oil stocks last summer!

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March 14, 2011, 2:20 pm

I agree with you on companies vs the commodity itself. Unfortunately, oil and oil stocks moved inversely with the recent price spike. It was the market’s way of saying “high oil is not desired”. Commodity stocks will not always follow the commodity!

March 14, 2011, 2:52 pm

I completely agree with you. Although, most commodities will continue to rise, based on inflationary pressures, they will mostly track inflation over the long-term. It’s basically just a store of money or a speculative play.

Well run companies, on the other hand, have an opportunity to far outpace inflation with growing earnings. I need to beat inflation in order for my investments to pay off. Otherwise, it’s not worth risking my capital.

Mike
March 16, 2011, 6:09 am

@Beating The Index,

Yeah, the message from the market was pretty clear. On the other side, if you take a day like yesterday, everything was going down (oil, gold, uranium)… According to me, it doesn’t make sense;

If investors don’t like Uranium anymore, oil is an alternative… hence both are going down.

If there is a panic, gold should be considered as a shelter…. duh!

Since there is nothing much to base your analysis on when you look at commodities, I rather see a stock going up and down but knowing that the fundamentals are solid ;-)

March 16, 2011, 12:00 pm

@Mike

Markets haven’t been very rational lately with all the fears out there. On the other hand, this is a period of opportunity for those who have the nerves to withstand volatility and are able to look beyond the bad news.

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