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!