Commodities make me sick
I get sick to my stomach every time I hear an investment expert saying that we should own commodities in our portfolios.
The purpose of investing is to get a return for your money
The purpose of investing is to get a return on your money. You buy a financial product and you get a higher value when you sell, you get a dividend, you get an interest payment, you get royalties, you get paid rent, and so on…
I am appalled when I hear financial experts suggesting that we should invest in gold and other commodities.
I wrote a blog called “Why investing in gold is a dumb idea.” The same principles apply to other commodities.
What are commodities
Let’s begin by describing what commodities are. Commodities are standardized goods and services, most of them are traded in an open market. It’s easy to explain commodities by giving you an example:
- Agricultural products such as wheat and corn
- Metals such as gold and silver
- Energy such as oil and coal
These products are actively traded in the commodity market and they might have a lot of volatility.
The people who make money in the commodities market are the broker houses that facilitates all the transactions. During the The California Gold Rush (1848–1855) the people who became millionaires where the ones selling the pick and shovels, not the miners. It’s the same in the commodity market, the people who get rich are the ones who sell the dream of commodities as an investment.
Commodities don’t make babies
The truth is that when you put two bushels of corn in a barn, they don’t have sex and produce a baby bushel. They just sit there, do nothing and you have to pay insurance and storage. Commodities are non producing assets, they are no different from any household item in your house, like a chair or a table, therefore they are not investments.
Anyone who insist that commodities are investment class, they want to sound smart, they want to make you feel as if you need their services and they are direct beneficiary of the service they are selling you.
Supply and demand
In the long run commodity prices increase at the rate of inflation. In the short run, commodity prices are influenced by the laws of supply and demand.
If there is higher demand than supply the prices go up. When prices go up consumer buy less and producers produce more, bringing the price to some equilibrium.
If there is higher supply than demand the prices go down, consumers start buying more, producers produce less and the price comes back to equilibrium.
Here is a graph of the Commodity index ETF for the past 5 years. As we have become more efficient producing commodities, supply have increase, the prices have gone down and if you were a believer of commodities as an investment, you have lost 50% of your money during the past 5 years. Show that to the person who recommended commodities for your portfolio.
Governments stop subsidizing commodities
While I am on the subject. I want to express that I dislike it when governments get involved in commodity markets. It costs million of dollars to taxpayers and to consumers. Governments all over the world subsidize all kind of agriculture products. This subsidy comes out of tax payers pockets. This is the subject for another blog.
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