Approaching the commodities market can be daunting in light of all the information out there and the pundits espousing their own particular views. In investing you should never rely solely on other's perspective in order to make investment decisions, one has to develop a process for assessing and evaluating opportunities that works for oneself. It will not always be correct but through trial and error, one can develop a rational approach. This does not meant to ignore the talking heads but rather figure out how they came to their conclusions. Jim Rogers has made his fortune and name in commodity markets and his approach should be studied. He provides a succinct and simple approach to evaluating the potential for commodity supply and demand in his 2004 book “Hot Commodities.” This set of questions was developed in reference to copper but it could easily by applied to other commodities as well.
Supply:
1) How much production is there worldwide?
a. How many reserves are there?
b. Is the production in areas that might experience turmoil?
c. Are the reserves rich with copper or only marginally productive?
d. What are the existing inventories
e. How many mines exist worldwide?
f. How productive are these mines?
g. What is the potential supply over the next years?
2) Are there new sources of supply?
a. Old mines expanding?
b. When?
c. How much will it cost?
d. How much copper will this expansion produce?
e. How long will it take before additional supplies get to market?
3) Are there new potential supplies?
a. How much?
b. How expensive to develop then produce?
c. How long before these new supplies get to market?
d. When will the new supplies get to market?
Demand:
1) What is the commodity most used for?
2) Which of the current uses will continue? (The wireless revolution knocked out demand for telephone wires, which use copper)
3) What alternatives are available to replace it if prices go too high? (Plastic pipes instead of copper ones, for instance)
4) What new technological advances might requires this commodity that did not exist before? (Computers, for examples created a new need for copper parts used in the system’s innards; cable systems picked up the slack in copper demand for telephone wires)
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This is one investor's approach to assessing commodity supply and demand but it is a good starting point to look broadly over a sector. The next step then would be to individually evaluate companies, a process that is a bit technical and nuanced. Investing is a head game and if you have the right framework, you can start to digest the massive amount of information out there and develop a rational approach to investing before it becomes the trending topic.
Keep calm and invest on.
Nicholas LePan
