Q&A: Are commodities worth investing in?

You’ve talked in your writing about a lot of different types of investments – technology, pharma, retail, real estate, etc. – but you haven’t touched on commodities like coffee or oil. Has it not come up because that's not really something that you favor or think about in investing?

I don't love commodities, but only because the prices are generally set by your least efficient competitor.

In other words, it's difficult for the best commodity producer to be better than the worst producer. There's a certain level of supply and a certain level of demand. Then, assuming it is a commodity, you're just going to source it from people that can supply it at the lowest price possible until their supply has been exhausted.

Commodities are also usually subject to major boom or bust cycles. Suppliers can make a lot of money during high demand times, but they lose a lot of money when demand is low.

At the end of the day, when you have an operation that's all about fixed costs, it comes down to whether you're going to be in a situation where you need to price it just above your marginal costs. Beyond that, it’s hard to differentiate yourself as a steel producer, a lumber producer, or an oil producer.

For my part, I just think there's easier ways to make money. When it’s this difficult to differentiate yourself, and the market is in a situation where the best producer is so similar to the worst producer, it’s a market that just has less interest for me. Now, if one producer can stand out in some way, that might change the calculus. Think about airlines. Many people don’t think of the airline seats they buy as a commodity – people often think of it almost as a luxury purchase – but it is highly commoditized.

But how does American differentiate itself from United? At the end of the day, unless there’s some kind of brand loyalty, a consumer is just going to search for the cheapest fare for a given route. Indeed, many of the “upstarts” in the airline business, those companies that are most disruptive to the industry as a whole, are those that compete primarily on price, like Ryanair or WestJet.

Yet, I’d argue that some airlines (Southwest comes to mind) aren’t really commodity airlines, or at least not as much. They've kind of figured out a different way to fly. They only fly a certain kind of airplane to keep maintenance and repair costs low. Their labor expenses look different. They fly to second tier cities that other major carriers bypass. They cultivate a different kind of flying experience. They’ve differentiated themselves in meaningful ways separate from price, and that might pique my interest as an investor a little more (although, to be fair, I’m not bullish on airlines in general).

Ultimately, I’ve just found that most commodity producers just aren't businesses that can generate very high return on invested capital; and they’re just not as interesting to me as other sectors.