November 21, 2007

Commodity as long term investments

Again another question to Bill Miller regarding commodity investing: Globe Investor Magazine: "A lot of investors in Canada are obsessed with mining and energy. Why have you been a skeptic on commodities? Well, we were wrong. There's two things. One of them is the secular case and the other's a cyclical case. Secularly, we have not been fans of commodities, broadly defined. That's because the empirical evidence and theory, both together, would indicate that commodity prices decline in real terms over time. Extractive companies, by and large, don't earn their cost of capital over the cycle. They can be cyclically attractive-buy them when the cycle's bad and sell them when the cycle peaks---but generally speaking, they tend to be trading vehicles, versus investing vehicles. In trading vehicles, you've got to be right on both sides. We prefer things that we can invest in for five, 10, 15 years and earn large amounts of money. The question now is, are we at a cyclical peak, or, as the bulls would argue, is it a secular change-that is, energy prices and copper prices and lead prices and wheat prices will now not decline in real terms from here. I think the jury's out on that."

That matches my belief about the whole "commodity super cycle" notion that explains the skyrocketing prices of most commodities. As a result you see red hot returns in commodity producing companies lately predicted on the Emerging markets demand fueled by their economic growth.

If you think about it why would you invest in a company that has no control over the price of what it is selling or its ability to create demand for its products for that matter. One of the most fundamental aspects of value investing is to find companies that is free to pass along increase in costs to its customers and to expand its markets. Commodity producing companies are a miss on both aspects. They can not price their products at all, it is left to market forces. Also commodity producing businesses have no ability to increase demand for their products by executing on their business strategies, primarily demand is left for economic forces that is outside of the company control.

I do not see commodity as an investment from any aspect. Value investing in commodity producing stocks is an oxymoron sort of speak.

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