Who says commodities cannot be in a bubble?

(Do not construe anything I say as an attempt to gloat; rather I make these posts to illustrate fallacies.)

One of the arguments given by commodities bulls is that commodity businesses can never in a bubble like the dot-com bubble. The reasoning was that commodity businesses produce something "real" and there is always demand for that product, whether be it steel, or iron ore, or oil. I don't think too many are making that argument now but it was a common argument I heard over the last few years.

Well, let's look at uranium, which wasn't a popular commodity like copper or oil but nevertheless rose substancially. The thinking was that uranium was going to be in heavy demand due to the numerous Chinese nuclear reactors that are being built. As far as I know, nothing has changed with the Chinese nuclear reactors (as a side note, this is another reason oil consumption in China, where diesel generators for backup power is popular, won't be as great as some imagine.) Yet uranium prices have collapsed:

(note: I don't know much about uranium and there are different commodities. Also, uranium market is very small with most contracts negotiated business-to-business so these price charts are not necessarily indicative of actual economics.)

The prices started collapsing more than an year ago and equity prices followed, but the fundamentals are becoming evident now. Uranium One (TSX: UUU) was an upstart that just wrote off two billion worth of assets. The market awarded a market cap of around $4 billion to Uranium One a few years ago but investors have been heading for the exits of late, with the stock off 80% in the last year.

It's one thing to lose money investing in dubious mortgages but it must be painful to take massive losses due to changing fundamentals. The resources owned by these companies have not materially changed but the collapse in uranium price makes them uneconomic. The problem for these companies--this applies to all commodity businesses--is that the outcome is outside the control of these companies. Whether prices will rise in the future will depend on factors beyond the control of these companies. You can see why value investors tend to shy away from commodity businesses. If you do invest, you may have to pay more attention to macroeconomics.

The commodity area at possibly one of the greatest risks right now is the precious metals complex. A lot of gold, silver, and platinum mining companies had horrible economics while gold was in a bull market (I'm sure this is surprising to some; the problem was the rising energy and labour costs, which often rose faster than the gold price.) And things aren't going to get any better now. If the US$ declines substancially and gold rallies then these companies may recover but otherwise they will struggle. Gold investors are valuing these companies on the basis of gold in the ground. But, as was the case with the uranium companies, if the deposits are uneconomic, these companies will have to take charges and the deposits will be essentially worthless--until the next bull market, possibly in 20 years.


  1. To the question of the post, certainly not me. They are just as susceptible to "parabolic dreams." (See http://researchpuzzle.com/blog/2008/05/28/parabolic-dreams)


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