Lesson 10: Pitfalls to watch out for and opportunities for gaining an edge

In yesterday’s lesson you learnt more about the benefits of blending both technical and positional analysis with all you have learnt about the fundamentals of commodity demand and supply.

Today’s lesson aims to highlight the potential pitfalls to watch out for as you continue your journey through commodity markets.

Avoid newsletters, or at least be aware of their incentives

Investment newsletters touting the fortunes of junior mining companies are written by people who want to sell newsletters. When something is hot that’s what they’re going to sell. But what’s that based on? In the main you should be very suspicious of sell-side research.

Avoid reacting to commodity price forecasts

Every so often an investment bank, fund manager or pundit will make a big song and dance about their latest forecast for commodity prices. You should treat these predictions as for entertainment purposes only. Do not make them the basis of your investment strategy.

My own research into oil price predictions shows that they are typically wrong by almost 30%, even when looking out just six months. Meanwhile, forecasters are generally very bad at spotting turning points in the price cycle. Remember, commodity price forecasts are marketing material for other services (newsletters, trading fees, banking, etc.), they are not there to help you.

Do your own research

One of the best ways to really understand a market is to do your own research. This doesn’t need to be an exhaustive study. You can do worse than picking up a long-term chart for a particular commodity and looking for the biggest spike or slump.

Then ask yourself what happened there, what could those in the market have known at the time that the risk of a dramatic change in price was looming?

Focus on where you can gain an edge

Instead of attempting to second guess the future direction of economies and markets, devote yourself to specialised research in market niches. These are the inefficient markets in which it is possible to gain a “knowledge advantage” through the expenditure of time and effort. In the world of commodities this might include energy metals – like lithium, cobalt and uranium – that are hidden from view to the casual observer, but for which the evidence is there if you only care to look.

Take a long term view

The growth in algorithmic trading in commodity markets means that, at least in the short term the price of a commodity may not reflect changes in underlying fundamentals.

This is an advantage for investors willing and able to take a longer term view. Eventually markets will reflect the underlying fundamentals; it’s just the timing that’s fraught with uncertainty.

Use a decision journal to avoid behavioural biases

Record your justification for a particular trade or investment, your thoughts on the likelihood of it occurring and how that compares with the current value. Crucially though, outline at what point you will know that your thesis was wrong and that you should try and get out of that position or try and hedge.

Do these things before you place a trade, when you should be at your most analytical.