No Guarantees for All that Glistens in Investing

By Tony Levene

A few years ago, investors could (apparently) not go wrong with raw materials. Buying into oil, cotton, coal, copper, wheat or wool was a guaranteed route to riches. But – no apologies for stressing this – nothing is forever. The economy is now into a really tough period for prices, with the only recent winners those who decided to bet on more downward pressure.

Most economists say this commodity collapse is because growth in the Chinese economy has slowed. It is still impressive by European or North American standards, but it is not what it was.

It’s always tough for investors to argue against the orthodox view. But it’s always healthy for your portfolio to look at the minority opinion. So here are a few points to ponder.

  • No economy can continue to grow at the rate of China for long. It’s simple maths. A backwards economy can double over a period. But then it becomes a medium economy where doubling is harder. Finally, it becomes a big economy so doubling from there is almost impossible. Had China continued to grow at the rate of ten years ago, it would be bigger than all the rest of the world while the rest of the world would not have been able to buy the output of its factories. It’s obvious. So why did commodity investors not prepare for this?

  • When prices zoom up far faster than the need for goods, they achieve a life of their own. Demand for financial products creates its own demand – and that may have nothing to do with what is really happening. Investors just see plus signs and jump on the bandwagon. And that creates a bubble which, like all bubbles, has to burst one day.

  • Mines and farms and other sources of raw material gear up when prices rise. So more supply comes on stream because it is now profitable to re-open old mines or firms search for expensive shale oil or pour more fertilizer on fields to increase food yields – often just in time for the demand to tail off.

When commodity investors finally woke up to the Chinese slowdown, prices crashed. The twelve months to the end of December 2014 was one of the worst periods ever in commodity markets.

All this has returned commodity investment to what it once was – something for specialists. Funds aimed at ordinary investors, such as oil or mining unit trusts, face a choice between shutting down or keeping their heads down until – and this will happen one day – prices move up again.

So commodities are moving off the ‘tactical diversification play’ platform to one for professionals who can pick and choose – both buying and selling. Many will use special computer programs – and achieve success. But nothing is forever and even those programs will one day start to look flaky!