Why Trading Commodities Isn’t a Get-Rich-Quick Scheme

I get worried when I start seeing signs that people think they can make a boatload of money with little work and no expertise. We can all remember the day-trading fad of the late ’90s, and more recently, the truly unfortunate notion that “flipping” real estate was a road to riches. Although commodity trading hasn’t quite reached that level, late-night commercials about cashing in on gold seem to be numerous, and banner ads about the promises of oil trading are commonplace.  What’s most alarming is that this all seems like a familiar scene from a movie we just saw.

The two most visible commodities, oil and gold, are having eerie déjà-vu price spikes. It’s not just those two commodities, though. Between summer of 2010 and early 2011, coffee, corn, wheat, copper, and silver all rose between 64% and 256% before pulling back a bit.

You can find any number of reasons to explain these hot runs; the simplest explanation is the global growth story. Over the past several years emerging countries have been experiencing unprecedented growth. Businesses and governments in China, India, and elsewhere have been demanding metals, lumber, cement, and other materials like never before. Meanwhile, as billions of previously impoverished people enter the middle class they want the same goods that residents of developed countries have long enjoyed: more cotton clothes, orange juice and coffee at breakfast, and meat for dinner.  This surging demand puts pressure on limited supplies, causing sharp price spikes.

Even so, putting money in commodities simply doesn’t pass my litmus test for sound investing. An investor who purchases a business, outright or through shares, does so because the cash flows returned should ultimately be worth more than the original capital invested. Similarly, when you invest in a bond, you eventually expect to be repaid your principal plus interest along the way. Commodities do not have cash flows, however, because in the words of the great Warren Buffett, they “don’t do anything.” They don’t make interest payments, nor do they have profit margins. Here is what Buffett said about gold at the Berkshire Hathaway annual meeting this spring: