Tired of Stock Manipulation? Try Commodity Indexes

Disclaimer: This post does not constitute financial advice. Author has no position in any of the stocks or commodities mentioned. Do your own due diligence before making an investment.

In the last few years you might have felt there is something wrong with the market. Meme stocks are through the roof. Bitcoin is higher than ever. And stock message boards have turned into swamps, stocked with paid bashers.

It can be stressful to hunt for value when the environment is a rigged game.

But you don’t have to play. There’s another game that’s similar. It still involves problem-solving, speculation, and investing. (You can also buy options.)

Welcome to commodities.

Commodities are raw materials that are often consumed in a manufacturing process. Things like sugar, coffee, lumber, and precious metals are all commodities.

The beauty of trading commodities is that the indexes that track the commodities are basically impossible to manipulate. Warning: The price of the commodity itself or related companies can still be manipulated.

Like this:

Imagine you own the largest coffee farm in Brazil (the largest coffee producer in the world). You want to make more money. Being a smart and enterprising business-owner, you pay some gangsters to burn down your neighbor’s coffee farm. Since they were the second-largest coffee producer, the available supply of coffee for the next few years has now significantly decreased.

Basic economics tells us that when the supply of something decreases, the price goes up. (Assuming demand stays the same. And since coffee is pretty addictive… that’s a solid bet.)

It’s reasonable to assume here that if the second-largest producer of coffee is put out of business that the wholesale price of coffee will go up. That’s an example of how the price of a commodity could be manipulated.

“But wait, David, I thought you said it was impossible to manipulate the price of…”

Indexes! It’s basically impossible to manipulate the indexes that track a commodity.

And for every commodity there’s an index that tracks it.

Here’s a one-year chart of the price of coffee:

@nasdaq

Here’s a one-year chart of JO, an index that tracks the price of coffee.

@YahooFinance

This is exactly what you would expect it to look like. When the price of coffee went up, JO went up. When the of coffee went down, JO went down.

Beautiful.

Movement like that is relaxing. Prices are doing what they’re supposed to do.

This is how the rest of the stock market should work, but stock prices are being manipulated by cheaters on both sides of the field. And that can be stressful. Especially if the company you’re invested in released great news and the stock dropped. Then you’re pulling your hair out.

The reason commodity indexes can’t be manipulated is because it would be instantly obvious. If the price of gold went up 10%, and GLD dropped 5%, the phone lines at the SEC would be ringing off the hook.

Manipulators can get away with this on regular stocks because most companies aren’t directly tied to a single commodity. The price of a stock is a reflection of its profitability and long-term growth potential. (Which is always debatable.)

The future prospects of a company can be fuzzy.

It’s a lot of long-term projections and discounted cash-flow analysis. It’s impossible to say for sure what a stock will do in the next 5 years, and that uncertainty is reflected in its price.

Commodities are also forward-looking. Sometimes these projections are wrong, and this where you can make a lot of money.

Here’s a one-year chart of Starbucks.

@YahooFinance

Notice how the Starbucks chart doesn’t follow the price of coffee at all. But this isn’t manipulation. Starbucks sells a lot more than just coffee. Breakfast, lunch, coffee mugs, coffee grinders, etc. And their expenses aren’t just coffee. There’s rent, labor, equipment, insurance, etc.

Starbucks coffee prices are static in the short term. It’s not like lobster at a seafood restaurant. You don’t pay the market price for a cup of coffee when you walk into a Starbucks. That would be annoying.

Every so often a coffee chain will raise their prices due to market conditions, but it’s not a daily thing. They might do this once a year, or once a quarter.

You need to be careful investing in commodities. Make sure the stock you pick will accurately follow the price movements of the underlying commodity. Even if you had predicted the crash of coffee prices from April to June, if you had shorted Starbucks you would have lost money.

Make sure you know what you’re investing in. (Or betting against.)

When the pandemic started, the price of lumber of crashed along with everything else. At its lowest, lumber was down by about 55%. This was a remarkable opportunity for anyone who could think a bit outside the box.

Markets were crashing due to Covid-19. Countries were going into lockdown. The price of gasoline crashed. It was expected that people would be staying home and not consuming as much.

The flaw in that logic was that it assumed humans could just sit on their bums all day and do nothing.

That didn’t happen.

We’re a busy species. We like to do stuff. We get cabin fever when it rains two days in a row.

What happened with lumber is people finally got around to building that deck they always wanted. Or that backyard shed. Or that guest cottage. Or maybe they decided to move out of their cramped downtown condo and build a new home in the suburbs. (A lot of companies told their employees they’d be working from home until 2021.)

Here’s a one-year chart of the price of lumber.

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Lumber is up about 270% from its May lows. You can see this reflected in the price of lumber stocks. But not all stocks moved at the same rate.

Here’s a one-year chart of some companies involved with lumber.

@YahooFinance

@YahooFinance

Not all gains are equal. Not all companies are equal.

An index that tracks the price of a commodity is a safe business. It’s not going bankrupt any time soon. These indexes are often part of a larger company. You might have never heard of State Street Global Advisors, but you probably have heard of the SPDR funds.

Like SPY and GLD, their two largest ETFs.

When dealing with commodities you need to decide how you’re going to approach making a bet.

If you’re looking for a stock that can’t be manipulated and will follow the price of the commodity, then you want an index that tracks the price. (Lower risk, lower reward.)

But if you want to make more money, then you need to do some research. (Higher risk, higher reward.) You’re looking for the answer to this question:

Which companies would benefit the most from my projected move in the commodity’s price?

In the case of lumber, it was the beaten down retailer, Lumber Liquidators. Their stock price went up a lot more than Canfor, an “integrated forest products company.”

Lumber Liquidators is up about 630% from its March lows.

Canfor is up only about 315% from its March lows.

Each of those would have been a better than straight up lumber, but also much riskier.

Canfor is a Canadian company. A lot of their lumber sales are to the US. The Canada-US softwood lumber dispute has been going on since 1982.

Lumber Liquidators is a retailer (not a great business during a pandemic), and the chart looked like it was going bankrupt. They’d also had problems in the past with dilution and executive pay.

But Lumber Liquidators stock went up more than Canfor because it had been trending lower to begin with.

Commodities are fun to trade because it’s a mental exercise making reasonable assumptions about future price movements.

If you think the pandemic is going to continue indefinitely, you might short gasoline. If you think that the vaccines will eradicate Covid-19, you might go long on gasoline. Although you could do a ton of research and determine that the opposite will happen. The butterfly effect has bankrupted more than one investor.

Commodities are unique because most of the time the raw material is consumed. Companies buy lumber, they turn it into lumber products, and then they sell them. The lumber does not survive this process. More lumber will be required in the future.

If demand for lumber is going up, then lumber prices go up. Most of the resources on our planet are finite. It takes a long time to grow a forest.

When investing in commodities with a shrinking supply you need to be careful. Prices don’t go up indefinitely. Even if we were to run out of lumber tomorrow, lumber has a ceiling. If lumber gets too expensive, then we would figure out an alternative solution. Maybe we’d go back to building houses out of stone. Or maybe living in caves. (Unfortunately, a real thing in certain places of the world.)

Commodity prices can be somewhat safe because each one of them has a floor, which is based on consumption. Commodities can’t go bankrupt. And they don’t often become useless over the short term. If you’re talking centuries, that’s a different story.

Thousands of years ago, salt used to be one of the most valuable commodities on the planet. It had many uses. People used it to preserve their meat. Militaries used it to destroy the agricultural capacity of conquered nations. (Called salting the earth.)

The word salary comes from the Latin word for salt.

Ever heard the expression: “Worth one’s salt”?

That’s a throwback to when salt was valuable. Now salt is practically worthless. We have it in abundance.

This could one day happen to commodities like gold and silver.

Especially if we start mining asteroids.

In summary: If you’re looking for a relaxing way to play along term market, free of intraday manipulation of equity prices, then take a stab at commodity indexes.

I recommend focusing on a single commodity to start. Learn everything you can about it. Study the historical price charts. What were the reasons behind the big movements? The flat periods?

Are people going to be using more of your commodity in the future, or less?

Good luck.