The current investment environment has created lots of opportunities, especially in the commodities space. It has also created lots of risks, as not everything that looks like a value opportunity at first glance is truly undervalued.
One such sector that can look deceptively undervalued at times is the commodity sector. I have always been fascinated by the commodity sector; it is a market where it is possible to make a lot of money very quickly, but it is also possible to lose a lot of money very quickly. While some entrepreneurs and investors have built huge fortunes mining and investing in commodity stocks, the volatility involved with commodity prices and the skills required to navigate the ups and downs of the industry means itâs almost impossible for the average investor to get ahead.
The worldâs largest commodity traders and commodity trading houses have earned fortunes from trading commodity markets because they have more information than other market participants.
This is vital in the sector, which is not particularly efficient. Pricing can be wildly different between markets, and buying an asset in one country and trying to sell it in another country can entail a lot of risks and challenges.
For the most part, investors do not see the profits achieved from these deals. They go into the hands of middlemen, fixers, traders and other third-parties such as shipping groups and pipeline conglomerates.
Of course, there are some exceptions, such as Occidental Petroleum (OXY, Financial), which is currently one of Warren Buffett (Trades, Portfolio)âs largest investments. This oil producer is, in the words of the Oracle of Omaha himself, doing everything ârightâ when it comes to looking after shareholders. Rather than spending cash flow on vanity projects, the group is returning these funds to investors, a rare exception in the commodity sector.
While investors might be tempted to follow Buffett and try and select some attractive opportunities in the commodity sector, I think it is worth keeping in mind the comments he made at the 2011 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting of shareholders:
"When we buy ISCAR, or we buy Lubrizol, or whatever, we donât run around getting a quote on it every week and say, you know, âIs it up or down or anything like that?â We look to the business. We feel the same way about securities. When we buy a marketable security, we donât care if the stock exchange closes for a few years. So when we look at Berkshire, we are looking at what we think can be delivered from the productive assets that we own, and how we can utilize that capital in acquiring more productive assets. And there will be times, you know, cotton doubled in price, much to our chagrin at Fruit of the Loom, but, you know, if you own cotton for the right six or eight months in the past year, you came close to doubling your money. But if you go back a century and try to make money owning cotton over time, it has not been a very good investment...
And people like to get in on things that have been rising in price and all of that. But over time, that has not been the way to get rich.â
Buffet made these comments when talking about the potential for gold as an investment, but they apply to any other commodity.
Commodities look very attractive as investments when prices are going up along with profits (which also causes lower price multiples). If youâre able to time the market, you might be able to make a lot of money (remember though, timing the market is almost impossible). However, for the most part, over the long run, commodities tend to be pretty terrible "buy and hold" investments, and so do the companies that manufacture and produce them.
Thatâs why I think it might be best to stay away from the sector no matter how lucrative commodity stocks might seem or how undervalued an asset like oil might appear. The long-term returns are unlikely to be attractive.
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