“I’m starting to think I should be focussing on less volatile investments.” It was an offhand comment, but it was clearly thrown in my direction in the hope I’d ask him to elaborate on the volatile investments he’d been focussing on.
Dabbling in the riskier end of the market, he revealed his form of diversification had been splitting his investment money into various commodity shares – oil & gas, gold, iron ore, uranium and coal. The outcome had been negative to say the least. Each one of those commodities had looked like great growth stories at one point in time, but they’d eventually fallen in a heap.
The various commodity declines had taken all those companies down with them. It had made for a painful experience for someone who thought they were diversifying by buying an oil producer, a gold miner, an iron ore miner and uranium and coal explorers. The recent oil decline appeared to be the last shock he could take.
Out of the shares he held, only one paid a dividend – the iron ore producer. And given the significant decline in iron ore prices that dividend was no longer a guarantee.
Each company was pegged to the fortunes of the sole commodity it was looking to exploit. And as is custom in financial markets, people can tell you why something happened after it happened, but they’re not good at seeing the future.
Given recent news, we’re all likely aware of the fall in oil prices. Oil consistently maintained a price above US $80 a barrel over the last four years. Given that consistency some people probably assumed it was safe to stay there. That was a bad assumption. It fell under $80 at the beginning of November and has continued to fall.
With supply building, anyone holding oil shares was leaving their investment open to a 50/50 decision – would OPEC cut supply? They didn’t and oil prices fell.
Gold prices have fallen from nearly $1900 to sit in a range of $1200-1300 more recently. There appeared to be significant speculation built into the nearly $1900 mark. Many people thought the world was ending and gold would be a true store of wealth. They assumed hyperinflation would take hold of the US as their Federal Reserve continued their Quantitative Easing (QE) program. QE recently ended and hyperinflation didn’t happen. Any gold miners basing production on elevated prices suffered significant pain.
We’ve covered the iron ore decline in a previous article. And that fall has continued.
It’s been a while since uranium was in the news, but in 2007 uranium prices spiked after the world’s largest uranium mine, Cigar Lake in Canada flooded. Supply slowed, new explorers popped out of the ground and then prices crashed, taking all those new companies with them. Any uranium company left then suffered a second shock after the Japanese earthquake and tsunami in 2011. When the Fukushima Nuclear Power Plant suffered a meltdown, so did the share prices of many uranium producers.
In response to lower prices and a heightened nuclear fear, coal became more in demand. Though like many of these other stories, supply caught up and subsequently governments looked to curb emissions. Coal prices have been on a steady decline since 2011. The share prices of coal miners have suffered a similar slump.
This rear view analysis shows there’s very little warning when an individual commodity declines, so having your investments tied to their fortune is akin to gambling.
When oil was over $100 in June no one was talking about an oversupply. When iron ore was setting new highs no one was talking about BHP and Rio Tinto massively increasing their production capacity. When gold was flying many thought it was a rational, not speculative, response to quantitative easing. No one predicted an earthquake and tsunami would derail uranium. Finally, no one predicted an oversupply of coal and China to set pollution targets and tariffs.
Diversified portfolios aren’t immune from declines, but with funds comprising thousands of companies across the world, bond holdings, listed real estate and cash, they’re better prepared to ride out the rough patches than a handful of companies doing business in a small amount of commodities.
Of course had he been a client I could have long ago explained this to him!
This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.
