Commodity Investing: Maximizing Returns through Fundamental Analysis

CHAPTER 1

Introduction

In 1980 Julian Simon and Paul Ehrlich bet $1,000 on the future price of five metals (chromium, copper, nickel, tin, and tungsten). Simon, who believed that human ingenuity would consistently improve the lot of humanity, bet that prices would fall in real terms, while Paul Ehrlich, who believed that a growing human population would increasingly strain the Earth's resources, bet that they would go up. The Simon–Ehrlich basket of metals was not the first commodity index (that title apparently belongs to the Economist Commodity Price Index), but their bet on the future change in price may have been the first derivative on a commodity index. The prices of all five metals declined in real terms, and Simon won the bet.

Today huge numbers of investors are taking similar bets, except they are betting not thousands of dollars but billions. Passive long-only indexing in commodities has grown from very little in 1991 to probably over $100 billion in 2007. Much of the inspiration (or sales pitch) behind the move to commodity investing is the same as Ehrlich's inspiration in taking the bet with Simon: a general belief that the world's growing population is increasingly straining the Earth's ability to supply commodities such as oil, grains, and metals. Inevitably China is mentioned. Demand is going up, supply is going down. What could be simpler? Or is it? After all, the world's population has been increasing for a long time yet, as we will show, when measured over the ...