Why Commodities Matter in Your Portfolio

Hi Investors!

In today's newsletter, we're unpacking multiple facets of the financial landscape. From the role of commodities to insightful tips, let's dive deep and enhance our investing acumen together.

In todays letter

• Learning: Dollar cost averaging strategy and why most people use it

• News insights

  • Google to invest $350 million in Iowa data center

  • Italy shocks banks with 40% windfall tax for 2023

  • SoftBank reports mixed quarter, says 'timidly' restarting investment

• Key takeaways from Mohnish Pabrai's video Q&A at the Value School

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Why Commodities Matter in Your Portfolio

Commodities, by definition, are raw materials or primary agricultural products that can be bought and sold, such as gold, oil, or wheat. Their prices are often a reflection of global supply and demand dynamics. Unlike stocks or bonds, commodities do not provide a cash flow, meaning their returns come from price appreciation.

A Brief Example:

Imagine Investor A has a portfolio purely invested in stocks, while Investor B has diversified 20% of his portfolio into gold. During a stock market downturn, where stocks decline by 10%, but gold appreciates by 5% due to its safe-haven status, Investor B's overall portfolio would decline less. If the stock portion of both portfolios declined 10%, Investor A's total portfolio would decrease by 10%. Meanwhile, Investor B's would decrease by only 8% ([0.8 * 10% stock decline] + [0.2 * 5% gold appreciation]).

Five Key Points to Remember about Commodities:

1. Natural Hedge Against Inflation: Commodities, especially precious metals, tend to be an effective hedge against rising inflation. As Warren Buffett once mentioned, “Gold gets dug out of the ground... Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility.” However, its price often rises when the real return of other assets looks poor.

2. Diversification Benefits: Commodities provide diversification due to their low or sometimes negative correlation with traditional assets like stocks and bonds. Charlie Munger, Buffett's partner at Berkshire Hathaway, often stresses the importance of not putting all your eggs in one basket.

3. Speculative Nature: It's crucial to understand that commodities can be highly speculative. Prices can swing dramatically based on geopolitical events, weather conditions, and shifts in global demand.

4. Storage & Physical Handling: Unlike equities or bonds, physical commodities require storage. Think about the costs and logistics if you're considering investing directly in commodities like grain or oil.

5. Different Ways to Invest: You don’t have to buy commodities directly. There are commodity-focused ETFs, futures contracts, and stocks of companies in the commodities business which offer exposure without dealing with the underlying commodity.

The inclusion of commodities in one's portfolio can offer unique benefits, especially in terms of diversification and as an inflationary hedge. But like all investments, it comes with its set of risks. It's essential to research, perhaps consult with a financial advisor, and understand your own risk tolerance and investment goals before diving into the commodities market.

Warren Buffett and Charlie Munger, among other value investors, emphasize the importance of understanding what you invest in. As Munger often says, "It's not about how much you know, but rather how well you understand what you know." Dive deep into commodities, and it might just be a golden (pun intended) opportunity for you.

News insights

Google to invest $350 million in Iowa data center

• Google plans to invest $350 million in its Council Bluffs data center campus in Iowa, one of its largest facilities, furthering its commitment to the region where it has already invested over $5 billion since 2007.

[📝Full article]

Key takeaway

• Google's ongoing investment in the Council Bluffs data center indicates its strategic importance for the company's digital services, suggesting a commitment to infrastructure growth and service optimization.

• For investors, this underlines Google's dedication to infrastructure expansion and potential growth in data-reliant services; they should monitor future initiatives in this direction without making speculative decisions based solely on this development.

Italy shocks banks with 40% windfall tax for 2023

Italy has introduced a sudden 40% tax on banking profits that were earned due to increased interest rates. This decision comes in response to the banks' reluctance to increase deposit rates, even though they've gained significant profits from heightened lending rates in recent times.

[📝Full article]

Key takeaway

The imposition of this windfall tax in Italy sends a strong message to financial institutions about the expectations of government regulators in Europe. For investors, this means heightened regulatory scrutiny on banking profit margins, and they should remain attentive to similar moves in other European countries, possibly diversifying their portfolios to manage region-specific risks.

SoftBank reports mixed quarter, says 'timidly' restarting investment

SoftBank Group experienced a surprise quarterly loss but indicated a restart in investment activity after its Vision Fund recorded its first profit in six quarters, primarily due to a valuation increase for Arm, a chip designer preparing for an IPO. Despite the boost from Arm, Vision Fund's overall performance was not as optimistic, and SoftBank reported losses, especially after some major investments like Alibaba, Deutsche Telekom, and T-Mobile U.S. faced valuation declines.

[📝Full article]

Key takeaway

This mixed quarter for SoftBank signals cautious optimism in the investment landscape, particularly as the firm shifts focus towards AI-centric opportunities with significant growth potential. For investors, this suggests a careful observation of SoftBank's strategy and portfolio choices, especially watching the progress of Arm's anticipated IPO and understanding SoftBank's renewed emphasis on AI innovations.

Key takeaways from Mohnish Pabrai's video Q&A at the Value School

Here are five key takeaways:

1. Experience in Running a Business: The speaker emphasizes the importance of having experience in running a business for investors. Warren Buffett's quotes are highlighted, emphasizing that being a businessman makes one a better investor and vice versa. The speaker believes that professional investors who have never run a business might be missing some fundamental insights. Entrepreneurs typically focus on a few key variables that drive outcomes, and investors need to understand these variables to make informed decisions.

2. Understanding Businesses Beyond Spreadsheets: Entrepreneurs often don't rely solely on spreadsheets to run their businesses. Instead, they focus on a few key variables that drive most of the outcomes. Investors should also strive to understand these variables and not just rely on spreadsheets for their analysis.

3. Growing Up in a Chaotic Environment: The speaker discusses growing up in India and how navigating its perceived chaos helped him see order where others might not. This experience has given him a unique perspective when investing in stocks, especially in low PE environments. He believes that growing up in such an environment has helped him identify gems amidst the chaos.

4. Investing in Emerging Markets: The speaker talks about the importance of not painting a country with a broad brush. Using India and Turkey as examples, he emphasizes that while there might be chaos on the surface, there are well-organized operations, structures, and great businesses within. He believes that his childhood experience in India has given him the ability to identify these opportunities in other emerging markets.

5. Investing in China: The speaker touches upon investing in China, emphasizing that it's essential not to generalize a complex country like China. He believes that while most of China might be outside his circle of competence, there are specific businesses, like Tencent and Alibaba, that he understands. These companies have had Western influences early in their journey, making them more multinational in their views.

[🎥Full video]

Stay tuned for more insights, and remember to stay curious, stay confident, and most importantly, stay invested.