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Five Common Mistakes in Commodities Investing

InvestorEducation / Resources Investing Mar 22, 2008 - 03:34 AM GMT

By: Andy_Sutton

InvestorEducation Best Financial Markets Analysis ArticleTake a deep breath. The rout may be over. It may not be. This is a time when commodities investors have seen their mettle tested once again. This is nothing new. As recently as June 2006, we saw the price of silver drop precipitously from nearly $14.50 an ounce to under $10; a drop of nearly 35%. Granted, this most recent correction may not be over yet, but so far, it has only claimed damage in the area of 19%. These types of corrections are perfectly normal in the commodity markets and given what we've been seeing in the equity markets, should not be at all surprising. That's the bad news. The good news is that there is once again a tremendous opportunity to pick up both bullion and related stocks at fire sale prices.


However, there are many potential pitfalls to investing in commodities and especially the underlying equities. While there are certainly many more than five potential missteps, it is both timely and appropriate to examine some common mistakes people make when investing. These examples go beyond technical and financial analysis, and deal with the psychology of investing and understanding the macroeconomic environment into which you are entering. To a large degree, these mistakes may be applied to any type of investing.

1. You have to believe.
Pure and simple. Too many people jump on the bandwagon late in a run and when things get hot, they are the first ones out the door; invariably at a loss. If you want to be a successful long-term commodity investor, then do your homework beforehand, pick your entry points and stick by them. Let's apply this to the most recent correction. What has changed? Has anything fundamentally changed? Are grain inventories any higher than they were last week? Has the US dollar suddenly become worth more than the paper it is printed on? Have people around the world suddenly stopped using energy?

The answer to all of these questions is a resounding ‘no'. Nothing has changed. You've done your research, you believe in the long-term fundamentals. Hang tight. I've been telling people that all week. If you've kept a little powder dry, then you are able to take advantage of the fact that your favorite things are on sale. If, on the other hand, you've tried to catch a shooting star and ended up with a falling knife instead, or even worse, borrowed money to do the aforementioned, then this has been an extremely stressful week for you.

2. Don't fall in love with stories.
The investing world is full of stories; some good, some bad, some downright awful. We saw a lot of this in 1999. Every new IPO had a story, a line or an angle. Precious few had any results or even the hope of any. If it was e-related, it had to be a winner. This logic doomed many a retirement plan during the 2 year bear market that followed; when the stories were separated from the substance. In the case of commodity investing, you must ask first and foremost “Do they have what they say they have?” A good follow-up question to that would be “Can they get it to market at a cost that not only makes the project economical, but profitable as well?”

If the answer to either one of these questions is ‘no', then you're taking a big risk and should proceed with the utmost caution. Certainly some of these companies become winners, but you have to understand that you're taking a bigger risk than with a proven producer. Read the information on the company's website, read the findings of analysts if any are covering the company. Call the company and ask to speak to the CEO. With many smaller firms in particular, you will find that the CEO's make themselves available to the investing public and want to talk to you and answer your questions and at the same time, promote their company.

3. Follow your companies.
Many people lose out by not closely watching their companies. Mining and drilling are 2 particularly uncertain ventures and things may happen quickly that change everything. A flooded mine, a power outage as in the case of the South African platinum mines, political issues such as the nationalization of an industry or project and just plain old bad luck can conspire to turn potential into a boat anchor, in some cases overnight.

There are a number of strategies people have used over the years to protect themselves from sudden events such as stop loss orders and hedging their investments by buying put options. The best method I've found is to keep an eye on your companies. Know what they're doing, where they're doing it and with whom they're doing it. Picking out areas of instability and staying away is a good idea also. For example, Canada has historically been a place of low political risk, although recently, we've seen that go by the wayside to some degree with Canada 's recent decision to begin taxing their royalty trusts as corporations. Things happen overnight, and some of the Canadian trusts STILL have yet to recover the losses sustained when the decision on the shift in tax structure was announced. Other areas such as Venezuela , and recently Russia have become off-limits for all but the most adventurous.

4. It's about more than just the US .
Another common trap investors fall into is only paying attention to what goes on in America . While there is no doubt about America 's ability to consume, the ability of others to consume can no longer be ignored. India and China are now going through their equivalent of the Industrial Revolution. They are consuming massive quantities of everything from metals to energy to food. They are building and putting cars on the road like never before. Their people are starting to get electricity in their homes. Infrastructure is being built at a rabid pace. Their economies are growing at a fast clip and show no signs of slowing. And even if they did slow, they still need more resources each and every year. There is a tremendous strain on the supply chains of nearly everything. We're talking just a few days' supply in many cases. One little hiccup and there is a shortage.

Don't be so quick to fall for the argument that a US recession means the end of the commodity boom. This news by and large is attributed in the media for this past week's selloff in commodities. Think long term. The world's population continues to grow; that will require ever-increasing amounts of anything resource-related. A huge mistake that is being made in that much of the advent of Far-Eastern society is being constructed on the belief that cheap energy will be available indefinitely. The United States is slow to adapt, opting instead to burn its food supply as a short-term solution to a long-term problem. All of these things are bullish for commodities and energy in particular.

5. Had a bad day? - walk away.
Don't get into the mindset that because you're in a solid long-term investment that there will not be bad days. There will be plenty of them. Nothing goes straight up, and nothing goes straight down. Don't fall victim to sitting in front of your computer screen and hitting refresh every 5 seconds during the bad times, or the good for that matter. You aren't going to change the markets by doing that and will only give yourself a headache. Plus, you allow doubt to enter the picture.

The next thing you know you're selling when you're down only to end up buying back later at higher prices. Walk away. Go do something else. Come back the next day. This past week has been a prime example of what happens in these markets from time to time. When everyone is screaming on CNBC that the run is over, and commodity bulls are as common as snow in June, the bottom is near. That is just the way it works.

You've done your homework, you know why you're investing, hopefully you read the first item and believe what you're investing in and more importantly, why. During this Easter weekend, may your burdens be few, your blessings plentiful, and my best to one and all for a Happy Easter.

By Andy Sutton
http://www.my2centsonline.com

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. His firm, Sutton & Associates, LLC currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar. For more information visit www.suttonfinance.net

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