Commodity investing: Order of importance

What to focus on?

Dec 12, 2023

I started investing in 2019 and I started investing in commodities in 2020 and I have continued investing in commodities to this day. I like the volatile boom-and-bust nature of it. I feel like it’s a great place to try to “buy when others are fearful and sell when others are greedy”. My biggest winners have been from commodity stocks. A lot of that is also pure luck from being in commodity stocks during 2020-2022 when almost every commodity surged. That allowed me to have many multi-baggers without even knowing anything about the companies, but as the market cooled off it became much less easy and it forced me to adapt.

“It’s only when the tide goes out that you learn who has been swimming naked.” - Warren Buffett

In late 2020 picking commodity stocks successfully was easy you could randomly choose any group of commodity stocks and they would go up. I remember typing “Copper mining stocks” or “Uranium mining stocks” on Google and investing in those companies and many of them would 5-10x in a few months.

But those times are not here anymore. The Covid period of zero interest rates and massive QE was a bad time for most things, but a great time to be in the market. Especially for commodities as prices initially went down combined with Covid restrictions there was a massive supply decrease in many commodities and then demand came back faster than expected into that low supply.

Source: Pexels, Eftodii Aurelia

There is so much text in this article. It can be jarring for a modern person with a short attention span(like myself) to read so many words in a row without regular shots of dopamine so I will sprinkle in some cute animal pictures as kind of a refuge from the wall of text.

Because I started in commodities during a special situation bull market I needed to cleanse myself of the easy money mindset that gets into you during bull markets. It was time to get my mindset to a point where it is suited to more normal times.

I have learned many lessons about commodity investing during recent years that I think will allow me to succeed in the commodity sector during normal times. In this article, I will go into one of the lessons I have learned that I call the “order of importance” What I mean by this exactly is what you focus on mostly when you’re looking at a commodity investment. What is the most important part of your thesis and what is the least?

Whether we are looking at a mining company, oil producer, or steelmaker we have the company itself, we have supply dynamics of the commodity they produce and the demand dynamics of the commodity they produce. Do we focus mainly on the supply and demand of the commodity and then find a company that benefits from it, or do we see an interesting company and then we look at the supply and demand of the commodity? I used to think the first option was the way to go, but I have come to think that the second option is a better way.

Source: Pexels, Ivan Cujic

Let’s go into my list to dive deeper and also explore how the list relates to the revered AlmostMongolian portfolio

Order of importance:

The company you are playing the commodity with or the company you are investing in despite the commodity it produces. This should be the main focus. You can lose money with a bad company in a bull market for a commodity and you can make money with a good company in a bear market for a commodity based on the execution, valuation, and the special situation with the particular company.
For example, Petrobras preferred shares are up 65% YTD (more if you include dividends) while oil is down around 10% YTD. This is because there was a special situation with the company relating to excessive undervaluation based on political factors. I thought oil would be like +90$ at this time, but despite me being wrong about the commodity picking the right company still allowed me to profit.
There was another oil investment I made which was solely based on my supply/demand thesis for oil and thinking the company would do well because of higher oil prices. I knew that it wasn’t a good company, but it had torque to oil price. This was Razor Energy. So when the oil price did not do what I thought it would the stock went down. On top of that, they have failed their production goals. That company is down 78% YTD and it sits at the bottom of the AlmostMongolian portfolio being reduced to being my smallest position reminding me to never again invest just based on torque to a commodity price. I do plan to sell it at some point unless they amaze me somehow, but not during tax loss selling and oil pullback. There is a perfect negative storm for Razor right now. And usually, there will be a bounce at some point.
I would categorize other commodity investments in the AlmostPortfolio like this. Globex and Algoma go into the category of a special situation where I invest despite the commodity. Africa Oil, Metals X, and Prospera Energy are hybrids between special situations, undervaluation, and me being bullish on the commodity they sell. But they are all mainly company-focused investments.
Source: Pexels, Sippakorn Yamkasikorn
The supply comes in second in the order of importance. One country, one area of a country, or one mine can produce a large part of the world’s supply and there are material events happening in these places. You can track supply quite well and see different events and circumstances with a particular supplier that can have large effects on the market. The supply/demand thesis’ I find appealing are mainly supply-driven.
I wrote an article about uranium about how I like the supply/demand thesis, but the companies are overvalued. That is a supply-driven thesis that has been working and the people involved in it have been able to track supply quite well and the demand part of the thesis has been something like steady or growing demand. That is usually the demand thesis. Another one which I like is tin. The thesis is mainly about supply problems in Myanmar, South America, and Indonesia and the demand thesis is steady or growing. Leaning towards growing. The same thing in oil the thesis the supply is the key part. OPEC discipline, US slowing supply growth, natural decline in many countries outpacing growth, Russia/Iran potential supply disruptions, and low amount of new discoveries. The demand thesis is again steady or growing depending mostly on the global economy.
Source: Pexels, Mike Bird
Demand. It’s very hard to predict and it changes less than the supply. Now you are trying to predict very large trends. You are trying to predict what the Chinese economy will look like which is notoriously difficult. Or the global economy which is also very difficult. People who try to predict these things generally do not make money in the markets.
Then you might try to predict demand based on some growing sector like Lithium and EVs. But what happened with lithium was that despite that EV sales have continued to grow and set records the lithium price has crashed, because of supply. Supply moves faster and is easier to predict.
Source: InsideEVs
Source: TradingEconomics
There are so many examples of this. This is why I put a higher focus on supply in my investment thesis.
I don’t ignore the demand, but in the order of importance, it is last. And of course, bad demand can destroy your investment or vice versa, but the key to investing is what we can know. What can we predict with reasonable accuracy? So the order of importance relates to what is the most influential factor combined with the ease of predicting it.

Source: Pexels, Miriam Fischer

I’m sorry if some of the animals were not that cute, but I could only find 5 animal pictures on the internet and I think one of the animals was extinct, but I have to work with what I can find.

Conclusion

This is how I will look at commodity investments from now on. You can imagine a pie chart where like 50% of Due-Diligence time is for the company 35% is for supply and 15% is for demand. These percentages are arbitrary but that communicates the basic idea.