Weekend reading: Commodities are risky and typically unrewarding

Good reads from around the Web.

Until you pay attention – as more of us have with ongoing the oil price crash – it’s hard to fathom just how volatile commodities can be.

Even veteran investors who have a handle on the ups and downs of the stock market can turn seasick looking at a graph of the choppy pricing of copper, corn or gold.

The stock market can seem a millpond by comparison.

The following table from US Global Investors1 shows how a metal like nickel can soar 154% one year before slumping 24% and then a further 55% in the following two years, and then rally 59%!

The original graph is interactive. Hours minutes of fun!

Slippery slopes

Being aware of this volatility obviously matters a lot if you’re an active investor.

It’s easy to get sucked into buying, say, oil exploration companies because they’ve fallen 20% on a 10% dip in the oil price.

After the oil price has fallen 80% and your shares are down 90%, you can reflect on your haste at your leisure.

Personally, I think commodity prices in today’s globalised and ‘financial-ised’ world are probably unpredictable even by experts.

That doesn’t mean you can’t invest in companies that churn them out, but it does imply that as a stock picker I want to be buying firms I judge can do well over a wide range of prices.

Now, many amateur experts will (in the good times) say different.

Hoards of private investors became part-time experts on the oil and gas industry, for instance, over the past decade, and on small cap gold mining companies for much of it, too, and loaded up their portfolios to the seams with such shares when prices were high.

And many have lost at least half their shirts in the subsequent rout.

I’m not belittling their expertise or ambitions. (That would be pretty hypocritical of me, given I am equally barmy in engaging in active investing myself.)

But I would observe that correctly judging which is the superior small cap oil company can be a hollow victory if it means that when the whole sector falls by 90%, you only lose 80% of your investment.

In this case you’d clearly have been better off out altogether. But from observation it seemed that many experts were wildly over-exposed – and emotionally committed – to the sector, and they followed the market down.

I’m not saying there’s never a time to invest in such companies. (Disclosure: I hope now is such a time, as I’ve loaded up, on and off, over the past 3-6 months).

But in my opinion, the hugely volatile nature of commodities means an active investor in the sector needs to be a confident trader, too, who is prepared to chop and change based on (gasp!) price action.

Passively poorer

Passive investors should also be aware of commodity price volatility.

That’s because every so often – usually after a couple of good years for the asset class – some people will start advising you to add direct commodity exposure to your portfolio as a diversifier.

I don’t mean to buy the major oil companies or miners that you will have exposure too anyway via your index funds.

I mean specific commodity exposure, through Exchange Traded Products or some other sort of futures fund.

From his own research, my co-blogger The Accumulator has typically been wary of that advice, and the latest US data suggests he is right to be cautious.

The following table – tweeted out by Morningstar’s editor-in-chief Jerry Kerns – shows how commodities have generally done nothing good for portfolios over the past 15 years:

Buy the dip?

Now you might be thinking this all sounds a bit defeatist. Don’t we normally suggest that slumps in a market can be a good time to buy in?

Well, I think that’s possibly true of companies that produce commodities, as I’ve alluded to above.

But being exposed directly to commodities themselves is a different matter.

Many financial assets – houses, equities, land – greatly appreciate in real terms over the long-term, despite the ups and downs on the way.

But there’s much less of that long-term appreciation in commodities in real terms, because we get better at extracting them and at exploiting them.

Perhaps someday that will change (that’s what the commodity super-cycle theory was all about) but it’s not done so yet.

And at the same time the prices are very volatile, so you’re basically adding risk without reward.

There are also extra costs and technical reasons why getting exposure to commodities via financial assets can be disappointing, too.

Let the smart money figure it out

As always, there will be exceptions – a few rare and successful market timers, whether by luck or skill, and some hedge funds and the like that have managed to get good returns over multiple cycles from the commodities markets.

But generally, I believe most people will be better off just owning whatever the global stock market owns when it comes to commodity-extracting companies.

And to leave directly buying the stuff for trips to the petrol station!

From the blogs

Making good use of the things that we find…

Passive investing

• Cost obsessed investors run amok – Abnormal Returns
• Why simple is still a hard sell – Canadian Couch Potato
• Indexing isn’t eating hedge fund’s returns – Pragmatic Capitalism
• Don’t just do something – stand there! [US but relevant] – Investing Caffeine

Active investing

• How to judge an investment process – A Wealth of Common Sense
• Topps Tiles is on top of its game – Richard Beddard
• What’s a sum of the parts valuation worth? – Oddball Stocks
• Stress-testing a levered portfolio – FIRE V London
• Value will triumph. Some day. – The Value Perspective

Other articles

• More data on corrections and bear markets – Vanguard
• Government bonds: The ultimate ‘alternative’ – Abnormal Returns
• The man who gets his cars for free – Mr Money Mustache
• Navigating pension changes – Retirement Investing Today
• How to protect yourself from mass job cuts – Financial Samurai
• Ambition is becoming a lottery – Simple Living in Suffolk

Product of the week: With the Bank of Japan imposing negative interest rates and the US economy slowing, global interest rates look stuck lower for longer. Peer-to-peer lending can boost returns on cash, but be very aware of the greater risk (your savings are not covered by the FCA compensation scheme, so there’s a low but real possibility that you could lose it all). I have been getting around 3% from RateSetter’s monthly market, but you can get near to 6% if you lock away your money for several years. You can also pick up a £100 new account bonus (and they’ll give me £50 as a finder’s fee if you follow the following link!) See RateSetter for more.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.2

Passive investing

• Video: Don’t cower in cash just because stock markets fall – Motley Fool

Active investing

• Being wrong and still making money – A.A.I.I.
• Seth Klarman lost money in 2015 – Business Insider
• Saudis “will not destroy the US shale industry” – Telegraph
• Strong case for value investing in Japan [Search result] – FT
• Lord Lee shares investment tips [Search result] – FT
• An interview with James Montier about Smart Beta and more – A.P.
• Reasons for the fearful to be fearful of gold – Bloomberg

A word from a broker

• Apple looks toothless compared to F.A.N.G. – TD Direct
• Where next for Lloyds now the big sale is off? – Hargreaves Lansdown

Other stuff worth reading

• London rents too high even for young bankers – Reuters
• Morgan Housel: How to make the world richer – Motley Fool (US)
• There are cons, too, to the oil price crash – Economist
• How pension changes could hit you, by age [Infographic] – Telegraph
• Is it worth moving your BTL into a limited company? – ThisIsMoney
• Free financial advice… at the food bank – The Guardian
• What does money mean to you? Take the test! – The Guardian
• Is American olive oil about to have its moment? – Bloomberg
• Revolt against the posh boys – Bloomberg View

Book of the week: Anthony Bolton’s Investing Against the Tide came out a few years ago, but I’m just getting around to reading it. If you’re a novice stock picker (or a slow learner…) you might feel it’s a bit flimsy – there’s no equations or rules in bold text. But after more than a decade at the active investing coalface, I now believe any skill in investing in today’s overwhelmingly efficient markets is of the marginal gains variety, and more reflective of an art than a science. Bolton’s anecdotal advice speaks to that. Of course most people will always be better off investing passively, but if you’re going to go down the stock picking route then at least Bolton has the chops to back up his soft-sell wisdom. He achieved around 30% averaged over several decades whilst running big funds for Fidelity – one of the greatest track records of all time. Not that you would know it from his very modest prose.

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1. Via Abnormal Returns. [↩]
2. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]