A professional investor friend says that all investments can be expected to yield the same return. I have never understood the rationale for investing in commodities, e.g., gold, on the theory that they are scarce. So I would press him to say that a backyard full of oil barrels would be just as good as the S&P 500. And then that a pile of granite rocks would also be just as good. And what about a backyard full of dirt since people will pay for fill? …
“U.S. Mining Losses Last Year Wipe Out Profits From Past Eight Years” is a WSJ article that doesn’t prove me right, since of course actual performance will not equal expected. But it should be sobering for those who love scarce commodities on the theory that “they aren’t making any more X”:
The U.S. mining industry—a sector that includes oil drillers—lost more money last year than it made in the previous eight.
Mining corporations with assets of $50 million or more recorded a collective $227 billion after-tax loss last year, according to Commerce Department data released Monday. That loss essentially wipes out all the profits the industry had made since 2007.
See also “Peabody Energy Files for Chapter 11 Bankruptcy Protection”:
Peabody Energy Corp., the largest U.S. coal company, became the latest to file for bankruptcy Wednesday, underscoring the fraying future of corporate coal mining in America.
The bankruptcy of the St. Louis-based company came after similar filings by Arch Coal Inc., Alpha Natural Resources, Inc., Patriot Coal Corp. and Walter Energy, Inc., all of whom have also recently sought chapter 11 protection.
Peabody’s bankruptcy sets the stage for a potentially bitter fight among creditors for its assets, which include massive open-pit complexes in Wyoming and Australia and underground mines in Illinois.
America may never again see a coal company as big as Peabody. Founded in 1883 by Francis Peabody with $100, a wagon and two mules, according to the company’s corporate history, Peabody grew into a juggernaut, producing coal for customers in 25 countries and employing 7,600 people.
But its decline has been precipitous in recent years. In 2011, Peabody’s value on the stock market briefly touched $20 billion. It is now worth $38 million.
Readers: Who has something nice to say about this kind of investment?
I agree completely with you, if your friend includes “commodities” as investments. Technically speaking a commodity is not an “asset” because it cannot generate value even though it is an input or a valuable resource. So it can be an “investment” but it’s a speculative investment, on speculation that it will become more in demand or more scarce because it cannot generate internal return like a (stock/bond of a) company or a machine can.
That said a company that produces commodities can be (a bad in this case) investment.
Commodity investing has something in common with shorting securities; you can go very broke waiting to be proved correct.
Gold Bullion is in my experience the best way to launder money. You can buy one ounce coins or bars. They can be hidden away from the government. They also are incredibly liquid. They can be converted to cash almost anywhere for minimal fees. Try doing this with pork bellies!
Gold and silver are highly correlated to all the other commodities, and don’t require leaky barrels or special warehouses or anything weird like that. So for commodities exposure just buy some gold and silver coins/bars and hide them in the attic.
The point of having some gold or silver is to hedge against negative real interest rates. This has happened many times in history and might happen again soon. So it’s a good idea as a portfolio hedge.
There’s the whole Harry Browne Permanent Portfolio theory. Gold/Silver to hedge negative real interest rates. Long maturity bonds for deflation. Stocks for inflationary growth. And cash for emergencies. You want some mix of each. Harry advocated even proportions.
My exposure to the oil business has led me to believe (rightly or wrongly) that its boom and bust nature is related to a cultural lack of risk-aversion. When things are good, they spend freely and reinvest heavily in the oil business (Six-figure welders in the Dakotas, for example), and there never seems to be a good plan for when oil prices drop back down. (Usually, everyone gets laid off, the fancy houses and fancy cars are sold off, and the businesses themselves struggle or go into bankruptcy)
It’s not super-hard to hedge against low oil prices (Futures contracts, airline stock, etc) but the entities in the Oil Business don’t seem preoccupied with it. Why should they when the political class has been talking about peak oil for decades?
The oil industry has done well for the last thirty years. Look at a chart of Exxon or of the XOI index. Oil is different from mining because oil depletes and isn’t recycled or stored in warehouses, unlike copper or gold. However oil and gas have become manufacturing businesses and Exxon and Chevron and other legacy companies have good reason to worry that their big, multi-billion offshore/LNG/oil sands projects are now uneconomical in a world of cheap, manufacturing style fracking, where costs are coming down every month. Exxon and Chevron are essentially IBM in a world of cheap PCs.
Commodities, like stocks, bonds, houses are for “traders” as opposed to “investors”. The advantage that many commodities have is that there are paper contracts, which allow many traders to trade them without the hassle or limitations of the underling physical item. The best part about many commodities is there really is a floor price and a real basic value. Somebody needs copper/pork bellies, etc for their business. Silver and platinum have a bigger “real” market than gold, but even gold has industrial and jewelry demands.
Houses are an interesting item. While houses used to be marketed as “investments” they really weren’t. They were depreciating assets. People wanted new houses, not old ones. (I know there were exceptions, but were talking assets classes here) Until the baby boomer started buying them en mass and the high inflation of the 70’s helped them not only keep their value, but increase in value; then they actually became an investment.
With the huge run up in prices in some markets and the rise of “house flipping” houses started to look more like commodities, but are a special class.
Timber is another commodity, that actually grows in quantity, and usually value, as you hold onto it.
As to why “invest” in them. Commodities are excellent items to “trade”. IF and it’s a capital IF, you can hold the commodity, like precious metals, or timber, then they can also be good investments. Timber especially has some interesting tax advantages and for retirement investing have similar time frames.
On the other hand, as others have mentioned, due to traders having such a major role in their prices, buying and holding (investing) can lead to some spectacular losses. Lots of people have lost lots of money investing in “solid” companies, like Enron. The stock market today is trading at such high multiples to earnings and/or book value, the differences between them and commodities is much smaller.
Julian Simon (free enterprise economist) famously bet Paul Ehrlich (Dr. Doom) that prices of commodities would always decrease (in free markets) as ingenuity increased productivity. Ehrlich preached that prices of commodities would always increase because of resource scarcity and impending catastrophes. Simon won the bet, and went on to say that the real resource is people rather than rocks/minerals/etc.
Meanwhile, after failed predictions in rising resource prices + exploding populations + mass starvation/famines, Ehrlich has gone on to revitalize his career by preaching about the impending doom of global warming. This despite 23 years of no warming measured by RSS satellite data, 30+ years balloon weather data, or 14+ years NOAAs pristine (uniform instruments calibrated+isolated) weather station data. Global warming only exists in the 80%+ weather stations contaminated by urban heat islands, sea temperatures measured next to ship engines rather than bouys, and made up data spread across the vast southern oceans that lack actual measurements.
Al Gorez – I think you’re behind the times. It’s ‘climate change’ now, not global warming. That way no one can be proven wrong.
I would rather invest in a finance companies as the margins they make must be astronomical. Some of the big international health and life insurance companies are probably good targets given the spat of mergers going on as well.
My two cents anyway…