Saturday, May 3, 2008 4 comments ++[ CLICK TO COMMENT ]++

The Debate Over Commodities

There is a huge chasm opening up in the value investing camp over commodities. There are several prominent value investors, such as Bill Miller, who avoided commodities completely over the last few years (and hence have underperformed severely). There are other value investors who are overweight commodities and believe they will outperform for many more years. (Non-value investors like Marc Faber, Jim Rogers, and others, have been bullish on commodities for almost 10 years now but let's just look at value investing.)

I have been bearish on commodities for over an year and been completely wrong. I used to be bullish a few years ago (mostly influenced by Marc Faber and Jim Rogers) but became bearish when I felt that it was driven by momentum and very little to do with any fundamentals (a good example is uranium, which is almost solely based on what may or may not happen in some of the developing countries.) I also switched my strategy from sector rotation to contrarian investing with a value focus, and commodities just weren't very contrarian.

From my readings, it seems most value investors avoid commodities or related businesses. If they are undervalued they may buy them, but in general they don't invest in them. Dereck DeCloet of The Globe and Mail, one of Canada's best business writers in my opinion, recently wrote a news story in the form of a fictional exchange between Warren Buffett and Seymour Schulich, a successful Canadian financier. The article touches on why value investors like Buffett avoid commodities. The points made by Buffett should be familiar to anyone who has looked at some past Berkshire Hathaway shareholder letters.

It'll be really interesting to see what happens over the next decade. Are we going to get something similar to the 70's, when commodities boomed and broad market stocks & bonds did terribly? Or are commodities going to collapse, while stocks & bonds do well? Or would everything collapse due to the unfolding credit contraction? My goal isn't necessarily to base investments on predictions but it's interesting to think about the possibilities.

On another note, CNBC blogged from the Berkshire Hathaway shareholder meeting:

Morning session
Afternoon session


4 Response to The Debate Over Commodities

May 3, 2008 at 8:19 PM

I don't agree with that article. Buffett has done plenty of non-value stuff, e.g. silver, betting against the dollar, betting on the Brazilian real (tied to commodities), CDS, etc. As for why he doesn't fool around in commodities a lot, maybe he thinks it's like tech, ouside his "circle of competence".

May 4, 2008 at 5:28 PM

Buffett does buy anything if it is undervalued. If the price is cheap or there is a reason, he will invest in commodities or commodity businesses (eg. ConocoPhillips, PetroChina, Posco). However, he has said many times that commodity businesses are generally not good investments. I vaguely recall him saying something to the effect that commodity producers are price takers in a market (i.e. they have no pricing power) and hence are poor investments. This is the opposite of most of his favoured investments (mostly in strongly branded consumer products or services) where the companies have immense pricing power and whose fate is not as dependent on supply & demand fluctuations.

I just Googled and found this article (can't vouch for its accuracy) summarizing Buffett's dislike for commodity businesses.

As Buffett's investments in Posco, PetroChina, ConocoPhillips, etc show, he isn't so concerned with the commodity sector per se. Some commodity businesses have pricing power or some other advantage (especially if you are the low-cost producer or sitting on a hard-to-find orebody). But most don't. We can't be certain that even a top company like BHP Billiton can sell its, say, copper at the same price in 10 years. In contrast, Coca-Cola will likely maintain its pricing and may even charge more.

May 27, 2008 at 1:57 PM

Good Post!

I am just starting my investment journey:

I was interested in commodities but after reading this I am not so sure. I will take the time to review the links you reference to get more insight on the topic.

In the meantime, I'll just continue to become more informed on the topic so that when it is time to make a decision, I can make a more informed decision.

Hopefully, any delay will not have too bad of an impact on any returns I would have made if I had invested earlier.

Be well!

May 29, 2008 at 4:08 PM

Thanks Alisa... I'll check out your blog... commodities can still go much higher but it's not my game since they have gone up a lot lot already...

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