Doom and Gloom?
It reminds me to what Howard Marks once said :” “I think it’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true : Cycles always prevail eventually. Nothing goes in one direction forever. Trees don’t grow to the sky. Few things go to zero. And there’s little that’s as dangerous for investor health as insistence on extrapolating today’s events into the future”.
To my opinion, this observation is more true when we talk about investing in the commodity-based companies : coal, uranium, copper, iron ore, oil or gas etc. Those companies by nature has no moat. They have no choice but become a price taker, not price maker. The price is solely determined by supply and demand, based on real needs or speculative motives. In addition, commodity-based company not only cyclical in nature and capital intensive, but also time-intensive.
For a donut shop, if there is supply/demand imbalance it might only need few minutes, or hours, to address the issue. That’s pretty much different if there is supply/demand imbalance in the market for, say uranium or coal. It would take years for the market to adjust and set a new equilibrium. It takes around 6-7 years for a typical commodity-based company from the early stage of finding potential resources to the production stage.
If there is more supply than demand in the market, and consequently the price gone down, the company could not simply close the store. With huge amount of investment already in place, taking decision to close the company might not be the right answer. Worse still, if the price correction occurred while the company still in the development stage. It would take sometime before excess supply disappeared and most inefficient companies finally flushed-down. It took painful years before the market correcting itself. A surplus put downward pressure on the price for a much longer period.
On the other hand, after a period of correction, and demand started picking up, unlike the donut store, the market might not be able to address the increasing demand right-away. That is the reason why the price can increase significantly until the new supply address the shortage in the market. And, as we know, it take years before the new supply entered into the market.
Having said that, I am pretty much agree with what Howard Marks further notes that : ”Ignoring cycles and extrapolating trends is one of the most dangerous things an investor can do”. Then, he reminded us to remember the following rules : Rule #1 : most of things will prove to be cyclical. Rule #2 : some of the greatest opportunities for gain and loss come when other people forget Rule #1.
If time is our friend, and we managed to catch the right cycle, then investing in the commodity-based company will reward us with a more than satisfactory return.
A margin and profit is the only incentive for a company to continue its production. If the incentive is no longer there, and when the cost to produce is higher than its price, then no company will be willing to make or produce it.
As long as we need uranium, there will be a new price equilibrium for uranium. And the uranium price will always be higher than the cost to produce. There is no other way.
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