IFB133: Intro to Investing in Oil and Commodities

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Dave:                                    00:36                     All right folks, we’ll welcome to investing podcast. This is episode 133 today. Andrew and I are going to discuss commodities and oil a little bit. We’ve not talked about these before and so we thought we would touch on this subject a little bit. So Andrew, why don’t you go ahead and share your thoughts with me and we’ll have our little conversation.

Andrew:                              00:56                     Okay. so you know, oil has been awful lately. Have, have you invested in any oil stocks as of late?

Dave:                                    01:06                     Uh not as of late, but about three years ago, I did buy a company called national Oilwell. Varco yeah, that sounds right. Yup, yup, yup. Yeah. NOV. Yup. I didn’t invest in them and I lost a lot of money and then I sold out of it. So that was not to the bottom at the time.

Andrew:                              01:31                     So, yeah, yeah, I remember looking back in 2013 and seeing that Chevron looked interesting. And if you look at their price charts since then, it’s been, they’ve done like absolutely nothing. I had bought a company that was oil services and I sold that one at a loss and then it proceeded to double from there. But I think when you look at the majority of oil stocks lately, they’ve been awful. Especially as this bull market has run up through the end of 2019, it seems that every industry is firing on all cylinders except for oil and not even oil. Just when you say, the energy sector that kind of encompasses all of that. And so as an investor, you know we want to try to stay within our circle of competence. And when you start to get into some of the more complex industries, something like natural gas, oil, crude oil things can get complicated. And it’s not always as simple as looking at customer behavior or, you know, as an example, I could be somebody who is a certain type of consumer.

Andrew:                              02:53                     And so when I see a business doing something that I like, I can take that and, and make a general observation that there’s probably a lot of other people who are also liking a certain company for their product. And then, you can look at the financials and that can kind of play out when you start to look at companies that are more complex or are dependent on other factors such as commodities. It can be a little bit more difficult, but I don’t think that it needs to be something where necessarily it becomes a thing where we’re never investing in these types of companies. I think it’s worth taking a look and finding ideas and opportunities. And if we can understand the basics of how commodities work, then we can at least have some competence. And then you can choose to become, you know, anything from an industry specialist down to maybe someone who’s at least aware of what factors are, are contributing to how your commodity business is either profitable or not profitable.

Andrew:                              04:11                     And I think that can help when thinking about these types of stocks. So if we think about commodities and I’m going to try to just kind of break it down and, and see where we can go from there. And it’s most base simple self-supply and demand and the way it moves, the price of a commodity is, is kind of simple. When there’s more supply in a certain commodity, then the price will tend to go down. As more and more companies compete and more of them enter the marketplace, the price does some pushdown. The opposite side of that is demand. And so when there’s more of a commodity in demand that’s going to rise, raise the price. And I hope that’s self-explanatory and simple to conceptualize. As a refers to oil in particular, there have been some events in the past that have either affected the supply or effected the demand and that has caused the price to go a lot higher than normal or a lot lower than normal.

Andrew:                              05:21                     So one, which I wasn’t a driver during the time, but Dave, I don’t know, maybe you might remember, was in the seventies or the 80s where there were lines to get to gas stations?

Dave:                                    05:35                     That was a little before my driving time, but it was, I’m old, but I’m not that old. Okay. What was the story behind that? Do you know? There was an oil embargo and the price of the gas went through the roof and there wasn’t enough gas to go around. And so the people had to wait in line to fill up their cars. It was pretty stressful. I, you know, I didn’t drive, but I remember my parents being kind of upset about it.

Andrew:                              06:08                     Yeah. So perfect example, supply gets constrained, and then along with that, with the irony of now when something’s more scarce and almost makes demand going even gray there, cause now people are probably freaking out and everybody’s trying to get their gas all at once.

Andrew:                              06:28                     And so you’re like squeezing the price from both sides. And that’s pushing that higher. So those types of, I mean that’s like an extreme example, but those types of forces are kind of counter about counteracting or are all pushing against a price of a commodity. And in real-time as it goes along, you’ll see these price fluctuations and that can do really big things or bad things for the companies that are participating in it. I’ll give one more example because this is very recent and it has to do with a stock in my portfolio. So one of the dividend fortresses, let’s see, how can I explain this without giving away the stock? So they had an African swine flu that broke out and China, and I think it was something three to six months ago. It, it decimated the park pop the pig population in China.

Andrew:                              07:32                     And it might have been a major contributor to why they, at least as of today, they’ve agreed to a phase one deal that has involved China purchasing a lot of agricultural products from the United States. And so that’s another example of because all of those pigs died. There is a huge drop in supply and that pushed the price of what do they call them? I think they call him pork bellies pushed it up. And so because of that, any stock any stocks that produce that commodity, you’ll see them get a huge boost on wall street as it’s clear to see once those prices of what they produce go higher than they can much easily have a much easier way to, to get more profits and push those profit margins higher. And then, you know, the fallout ramifications of all of that with the new agreement regarding agricultural products pushed up a stock like the one I owned and a lot of the other stocks in other industries that benefit from such a deal.

Andrew:                              08:49                     So you can have a lot of these different events, different developments. It can be the weather; it can be a disease. Like, in this case, it can be a war politics some fire and explosion. Anything like that can have a huge impact on the price of a commodity. Because if it throws off the imbalance, creates an imbalance between supply and demand, then they can push prices up one way or the other. And then over the longterm, you have all of these forces pulling together. And so when you talk about big longterm trends consumer behavior trends, the way that business is done and, and different innovations and how those change industries, then those longer-term trends can pull commodity prices higher or lower over the long term. And that also has a major effect on different stocks and businesses and their profitability.

Andrew:                              09:56                     And so while I think you look at a stock that’s a commodity, you can’t know exactly what is going to be the main driver behind its price. But I think you can get a general sense of, at least from a historical standpoint, what has pushed the price one way or the other over the longterm. And maybe will that continue or not. And I think that’s a thought that needs to go into your head when you’re looking at a stock that is primarily based on commodity products such as oil, lumber any those companies. Is that, am I missing anything from there? Like did I lose the audience, do you think at any point? No, I don’t think so. I think that all made sense to me. I guess a couple of questions I have if I could. Yes, please. Okay. So when you’re thinking about commodities and you’re trying to determine to invest in a company that deals primarily with a commodity, let’s say like an oil company, do you have to not only understand what the business does and how they do what they do, but you also have to factor in the ebbs and flows of the commodity world.

Andrew:                              11:15                     And does that add more or less risk to the investment? Yes, you have to have a Ph.D., and if you don’t know how oil is produced okay. But I will say this, like, to be fair, I am not a commodity investing expert by any stretch. I’ve had my different stocks of that boughten that produce commodities. One has done very, very well that has been with timber. I had that oil services equipment company that didn’t do so well. You didn’t do so hot. But you know, I think these are all things to consider. What’s interesting is I think a lot of the conversation goes towards consumer-facing brands and those stocks, and there’s not much talk about commodities and I think a lot of that has to do with the S economic cycle too. So I, I don’t, I don’t want to give like because I don’t feel that like I’m not like the commodity guy.

Andrew:                              12:24                     So I don’t think I, I’m at a position where I can give hard and fast rules and say that you need to do this or you don’t need to do that. What I’m hoping to kind of spurn is like another idea, another thought process of if I can understand this a little bit better, then maybe I can take those next steps towards investing in these types of companies. So something else that kind of pops into my mind to having that thought process and having that discussion with yourself when it comes to these commodities is so something you can also observe that that’s been true for many decades. There’s no guarantee that this is going to happen over the future. But as the stock market tends to go up, commodity prices tend to fall and vice versa. So they have what you call an inverse correlation.

Andrew:                              13:25                     The best way I can logically explain it is what a lot of businesses are. They have a cost to do business. So if you’re you know, selling t-shirts, then the cost of cotton is going to impact your profits. And you know, this kind of goes throughout with the whole economy and everybody’s different products and services. So when commodity prices are lower than a lot of the companies that use those commodities to make their products, they’ll have fewer costs involved with that business. And so their profits will tend to be higher and that increases the money supply. And talking about some of the economic forces we’ve talked about in the past. It can snowball and compound and make the money supply across the whole economy grow. And so that, why do you think that does the stock prices, they’ll push them higher.

Andrew:                              14:29                     And so on the flip side, you see at work and the other way too commodity prices get more expensive. You add the factor that when things are fearful and when the stock market’s not doing well, people tend to value hard assets more than, you know, like a paper asset, like a stock which is more intangible than they, they like things like gold, silver, they like any, any commodity is, is also a hard asset. And so investors tend to like that and there’s you know, those pressures on margins and the different things that push some companies out of business also can push commodity prices higher. Cause going back to the previous conversation, when you are lowering supply; you’re pushing that price higher. And so as supply is dropping and companies are dropping out of the race, so they say that can push the commodity price higher.

Andrew:                              15:32                     So it’s not an exact science in the sense that it’s, there’s no guarantee that, Oh, the stock market went up, commodities are going to go down the vice versa. But over many years it’s been observed that generally, you can see this kind of phenomenon. So I think it becomes even more interesting though is when I am determining which stocks I want to buy. And if, as an example in my scenario, let’s say I can’t find a dividend fortress to save my life, I can’t find a good brand name. That’s trading at a reasonable price because the ones I have bought have gotten up and been pushed up nicely. And the ones that I’m, I haven’t bought maybe are just still too expensive. Or the brands that are around other cheap are just terrible businesses, terrible brands. So it’s like, you know, what’s in the best of the duet at that point.

Andrew:                              16:33                     And so maybe it’s, it’s prudent to look for those type of commodity businesses understanding that, Hey, it’s not going to be like, in my mind, I don’t know, in my mind, I think the LA, the shelf life of a commodity type business is, is lower. The competitive advantages of a commodity type business are going to have to do with scale. So, you know, a lot of it is competing the, to the bottom and just competing on price. And so when you have a bigger business and bigger systems, right and, and more efficiencies than the bigger you are, the better you can compete. Over the longterm. It’s, it’s, I think it’s hard to maintain that kind of competitive advantage. And something like a brand or something that’s consumer-facing is it has better longevity wise. But I think depending on where you are in the economic cycle or the stock market cycle, I think there’s a lot of opportunity for some commodity type plays to, to be good, quick kind of value on lockers.

Andrew:                              17:54                     You know, places where you’re looking for a margin of safety, and you’re hoping that margin of safety closes up quick so that you can make some gains and move on. So, those are the thoughts to, not to answer both of your questions at all. Those are the thoughts that go through my mind when I think of whether some of the risks with commodities, whether some of the basics, but also where, where are the opportunities? And I think like an investor; if you’re going 100%, I’m going to ignore commodities or under percent inequalities. I think both approaches are bad, but I think it’s, it’s a good diversifier to have some commodity producers in there. And, and maybe, you know, not, not having the heaviest way, if you’re not 100% confident on the industry, but having some exposure and if it still falls within all of your principles and fundamentals, then you know, then that that has even better chances of, of doing well outside of, of all the other thoughts and discussions that would go along with it.

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Dave:                                    19:16                     That’s interesting. I think the, I know you got a summary [Inaudible] from an article you read recently in barons from Peter Lynch, and he was talking about commodities and energy in particular and oil in particular as something that he was interested in. And I think as we were talking about this, it kind of makes sense that somebody like him who’s more of a value-oriented type investor would be looking at an industry that’s been beaten up and it, I think commodities and oil in particular probably would fall into that category and like, you know, I feel like financials have been beaten up for a while. I think probably that would be something that he would want to investigate in a; I think it’s a great place for you to dip your toes maybe in and see what you can learn and see what would be an interesting idea for sure than it is. That’s where a lot of these people that we look up to like to fish, so to speak is where other people are fishing. That’s the best place to go to try to find new ideas.

Andrew:                              20:26                     Those are, yeah, those are great points. Both Peter Lynch and Warren Buffet, they’re both known for buying into stocks that continue to grow. Right? Peter Lynch is this big growth investor, but he also looks for value like you said. And he talked about how he thinks there is a lot of different oil stocks that have the potential to triple very, very quickly in, in the next couple of years. And Buffet too. Like he, he’s loading up, I don’t want to say loading up cause that that word sounds may be more descriptive than it is, but he’s, he has him, his waiting in banks. Right? So he sees, he sees the pessimism around banks and you know, he’s well known for Coca Cola and that great growth story that it was, but he also likes to play in the place where everybody’s fearful. And so, yeah, I think when you look at both of those two investors, they’re great examples of that, where they’re not a hundred percent value, they’re not a hundred percent growth.

Andrew:                              21:36                     They’re taking what the market’s giving to them, and if the market’s giving them a Coca-Cola, he’s loading up on Coca-Cola. If he, if it’s giving them financials, he’s, he’s, he’s finding, those great discounts and, and closing some quick profits. So I think it’s, I think it’s worth looking at oil in particular at this time or let’s say the energy sector in particular. And the thing that I want to echo that Lynch said that is making me, again, I’m just looking at it and finding ideas, but it’s not like I’m going all out tomorrow and I’m buying a bunch of these stocks. But he said that the way that wall street is perceiving the energy industry right now is that everybody thinks that electric cars are going to be 100% implemented tomorrow. He says there’s still a very big utility for prude oil dirty oil, right?

Andrew:                              22:37                     Coal. the type of all economy energy sources, there’s still a lot of use for them in the next 20 years. And so like I’ve certainly put some plays in my portfolio that kind of go against oil, you know, and I think the trend eventually is, is to completely sustainable alternative energy, clean energy, all of those sorts of things. But if the opportunity right now with the way it’s been so beaten up is saying that Hey, maybe in the next five years this is a great opportunity, then I think it’s worth mixing that in. And, and you know, I think it’s, as I get more and more experience as an investor, I think when I have tried to do is have that different kind of mixtures. And so when you think about the first find a portfolio, it’s not just with particular stocks, but that’s also with what you hope the stock does.

Andrew:                              23:39                     So maybe I hope this stock can give me above-average return over the next three to five years versus another stock that I hope will give me 30 years of growing dividends. Those are two, both very different results and they’re going to have, they’re going to need two different types of businesses in two different types of economic conditions. And so I think mixing a lot of those and you’re not always going to know which stocks are going to go, which way or which business is going to perform exactly as you like. But I think to spread your bets enough where you have opportunities to hit one way or the other. I think it’s a smart thing and I think it’s worth considering. I would check out Jim Roger’s book hot commodities. It’s something he wrote years ago. But it definitely helps get insight into how these hard assets like commodities, how, how they work and go more in-depth into that and get a better understanding. I think that’s a, it’s a helpful book and that has been for me so far. Awesome.

Dave:                                    24:49                     All right, great. All right, well folks, I think that’s going to wrap up our discussion tonight on commodities, and I hope you learn something. I know I did and it was very interesting for me. So without any further ado, I’m going to go ahead and sign this off. You guys go out there and invest with a margin of safety emphasis on the safety, have a great weekend. We’ll talk to y’all next week. All right.

Dave:                                    25:10                     As a side note, folks, we are going to be closing are Investing for Beginners masterclass on January 3rd, so this will be your last chance to take a stab at it. If you are a beginner and looking for a great place, a foundation to kind of start, this is going to be a great place to start and if you’re like me and you were looking for a place to kind of fill in some gaps, this would also be a great choice for you as well. So without any further ado, I’m going to go ahead and sign us off again and you guys have a great week, help you at a great new year and a great holidays and we’ll talk to you next week.

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