How Investing in Commodities Can Prevent a Personal Financial Crisis

Here's an important point to remember about any financial crisis you should happen to encounter between now and your retirement: it's a financial crisis, not a personal crisis. Life goes on even when money dies.

We were reminded of this point after reading a recent interview with fund manager Simon Mikhailovich of Eidesis Capital. He was asked about the ability of financial weapons of mass destruction (derivatives) to destroy the financial system. 'They destroy money, not lives', he replied.

'Human history', he adds, 'is ultimately the history of ebbs and flows of wealth, and the ability to preserve wealth over time requires a very proactive approach. Secular changes that disrupt technologies are traditionally very, very difficult and many will lose. But some people will win.'

Amen to that!

Bear markets destroy money and belief, or at least they will if you let them. The aim in a bear market is to preserve your wealth and not let it destroy your life. Obviously it's nearly impossible to separate your financial health from your quality of life and mental health. But maybe that is the biggest challenge of all when the world is turned upside down by monetary intervention: don't let it ruin your life.

Hackneyed advice? Perhaps. But it starts to mean more when you reduce it down to specific investment strategies, which all of us here at DR headquarters try to do in our own way. Take commodities for example.

Conventional Commodity Investments

The conventional investment approach would be to simply buy BHP and Rio Tinto and assume that the next ten years will be like the last (as good as it gets). But that would be a mistake. Why?

The future of bulk commodity exports is higher volumes and lower prices. This doesn't necessarily mean that 'peak profits' have been reached for the big resource firms. But it does mean the biggest share price gains (if not the safest) in the commodity sector probably won't come from coal and iron ore companies.

But as usual, don't just take our word for it. 'Australia's bulk commodity (coal, iron ore and LNG) export volumes are projected to more than double in between 2012 and 2025', reports the Bureau of Resources and Energy Economics (BREE). 'The large projected volume increase will help offset expected declines in bulk commodity prices and allow Australia to maintain the value of its mineral and energy exports', says BREE's Executive Director, Professor Quentin Grafton.

The good news is that BREE expects demand will increase for Australia's most lucrative resource exports. The bad news is that supply from non-Australian resource producers will increase too. The whole pie will get larger, but it won't necessarily be any more profitable.

BREE reckons that demand from China and India should drive coal, LNG, and iron ore exports. But it also reckons, 'Australian exports to these markets will face increased competition from countries such as Indonesia and Mongolia (coal), Brazil and West Africa (iron ore) and North America (LNG).' That's about what you'd expect in a mature commodity bull market. Investment in new capacity starts to catch up with demand, even as demand grows at a steady rate. The result is falling prices, but hopefully, for RIO and BHP, steady profits on higher volumes.

Unconventional Commodity Investments

That means that, if you're hunting for bigger share price gains, you're going to have to go out on the margin. This is what our mate Alex Cowie has done at Diggers and Drillers. The idea is to find what Alex calls 'strategic minerals' in demand for the 21^st century, where supply might not be as prolific.

There's a lot more room for big price moves in the underlying commodity in the 'strategic mineral'. That means there's obviously a lot more room for big share price gains as a small number of suppliers benefit from prices (if they do in fact rise). Alex's latest efforts also support the idea that financial crises come and go, but life on Earth persists.

One example is graphene. It's quickly turning into the superhero of 'strategic minerals'. So far its superpowers include being stronger than steel, thinner than paper, capable of turning light into electricity, and now, of 'increasing the efficiency of desalination by two or three orders of magnitude', according to new research.

This is a high profit-margin future for commodities, in materials science and in new applications. A lot of the research in materials science is related to increasing energy efficiencies (especially in solar panels that create a kind of artificial photosynthesis). But the point is even simpler.

Some commodities add more value to the economy than others. Those commodities are generally less understood, harder to find, and more expensive to produce. But the companies that do find them and produce them could be excellent speculations. Life goes on. Technology is a tool for enhancing our quality of life and advancing our ability to make things. A financial crisis doesn't change that.

Dan Denning
for The Daily Reckoning Australia

From the Archives...

The Biggest Fraud in Economics
2012-06-29 - Bill Bonner

Why India is Buying Gold
2012-06-28 - Greg Canavan

Is the Silver Price Finally Bottoming Out?
2012-06-27 - Tim Staermose

A Giant Game of Currency Chess
2012-06-26 - Dan Denning

An Open Letter to the Fed: What's Your Number Ben Bernanke?
2012-06-25 - Keith Fitz-Gerald

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