Saturday, May 6, 2017

Commodity-Related Companies for the Commodities Asset Class?

A question popped up by one of my friends with regards to the commodities asset class in The Bedokian Portfolio. He asked instead of getting gold, silver and oil, could he replace them with gold and silver mining, and oil companies? After all, they are in the commodity business.

To give my answer, it will be a “no”.

Why No

The main aim of the commodity asset class is to have a form of insurance against the volatility of the markets, in accordance to reducing portfolio risk through diversification of asset classes1.  That being said, it is better to own “as direct as possible” the commodities, be it physical or through ETFs that track their prices.

On the other hand, when you buy into a gold/silver mining or oil company, the price of the commodity itself is just one part; you are also buying into the company’s assets, liabilities, management strategies and styles, etc. In fact, you are actually buying into the equities of the company which belong to the, obviously, equities asset class.

For example, when the price of gold goes up, there is a high chance that the share price of a gold mining company will go up as well, but how proportional this increase is will depend on other factors of the company, such as costs of mining, the productivity levels, etc.

If the price of gold goes down, a mining company may not want to mine them as the amount may not be worth their expenditure effort. If this prolongs, it may run the risk of bankruptcy due to cash flow problems. As with all companies, the bottom line is still the most important. For physical gold or gold ETF, however, it just remains as it is without much of the factors and risks described earlier.

So Can I Still Invest In These Commodity-Related Companies

Yes you can, but remember to put them in your equities asset class rather than the commodities one, and also provided you do proper fundamental analysis before going into them.

1 – The Bedokian Portfolio, p37