Archive for January, 2012

Commodities That Increase With Inflation

commoditiesWhile reading a finance forum, I saw the comment that commodities are destined to increase with inflation and therefore a good long-term investment. I found this comment so ridiculous that I had to write a quick post about it. So before you go invest your entire portfolio in oranges or corn, take a look below.

First let’s talk about what a commodity is –  a commodity is a basically any marketable item, usually fungible and are usually in some sort of “raw” form. Some examples would be milk, meat, wheat, tomatoes, grapes, eggs, beans, olives, wool, copper, and oil.  There are many types of commodities, but I’ll give a common example a commodities transaction.

Image you are General Mills and you need a large amount of wheat for your products, and you have enough for wheat for this year and want to also make the product next year– You may want to pre-buy your wheat for the for-seeable future, but you don’t really want to store it in a giant container (for various reasons) you just want to pre-buy what will be later farmed, so you buy a commodity future with the market (who is ultimately backed by the actual suppliers). If wheat was trading for $263.45 per metric ton ($7.17 a bushel) today and you needed 100,000 tons a year for production of your product you are going to need about $26,345,000 worth of wheat. If something were to happen to the supply chain such as a shortage, the prices could increase.

wheat

To be safe you buy the right to purchase that $26,345,000 worth of wheat, (at today’s prices) that you will need next year for a premium that is based off factors of how likely it is to increase (the higher the risk – the higher the premium). For example you might pay $1,155,000 million  for a guaranteed future purchase of that 100,000 tons of wheat 1 year from now at today’s prices (spending $1.115 million today and paying $25.345 million when you actually execute that right for a grand total $27,500,000) From there it is pretty basic math. If the price would have went up 10% it *would have cost you* $28,979,500 so you saved $1,479,500 by pre-buying the right. That being said – you could decide that it would be better for your company not to make the product and to simple sell the rights to that commodity for a $1,479,500 gain.

So let’s go back to that forum post. The idea he presented is this – We usually have inflation and commodities are affected by inflation so in other words it’s free money. This statement is ridiculous and here is why.

1. “Commodities go up by inflation” — Your Net Gain – Zero
Hate to burst your bubble here, but if something is increasing by just inflation it is a stagnate investment. You have no more money today than yesterday.

2. “More population, more demand — thus prices increase”
More people means more demand.. sure it does, but it also can mean more production. More farms, orchards, mining operations, etc. that result in an increase in supply.  Not to mention that even with more people, there can be other factors (such as a recession or depression) that can change how these people buy. If half as many people buy from a population 50% larger, you still are selling less than before. (1.5 population * .5 = .75)

3. “XYZ is in shortage and prices have to increase”
Temporarily – maybe. Long-term – Maybe not.
I love cuties (little clementine’s) and if there was a massive demand for these little guys this year – odds are the prices might increase – but then you would have something else occur, more people would start growing them (because demand has gotten high). All of the sudden – next season — there is plenty of inventory and prices are back to normal or maybe even lower than the start.

GasDepositDiagram

4. “You only have a set amount of area you can produce XYZ”
This maybe true but there are few things to consider. For things such as crops limited to a region – technology is getting better and some crops are even genetically modified to have higher yields. If science suddenly finds a way to yield 20% more fruit in a particular crop, it’s going to quickly be in surplus. As for non-farm commodities such as natural gas – if the price does actually go up, it can open new areas up for exploration. Maybe natural gas isn’t worth mining out of shale drilling because of cost – but if prices double, the shale drilling might become viable and provide resistance to prices.

Conclusions:

Do I think all commodities are a bad investment? Not at all. In fact, if I had a lot of money (millions or billions) I would consider investing in commodities such as copper because the world demand could make these prices go berserk in the foreseeable future with the rest of the world developing. The point of this post is that people who say “commodities will increase with inflation making you rich” (or something to this effect), simply smile and nod – but do not encourage such crazy talk. Remember – it’s your gain ABOVE inflation that is truly a gain.

Rentals Investment Assuming 0% Yearly Appreciation

Buying rentals to increase your net worth and/or provide a steady steam of positive cash flow can be a great strategy to becoming rich with real estate, but what is your rental making you in actual case and how much of your “gain” is financial black magic?
 
I constantly talk about real estate on this blog, because real estate is my passion. I constantly run numbers on rental properties to see how viable they are and usually I am very disappointed. As always I would like to give a real world example.
In Cincinnati there is a neighborhood named Oakley which I think is a desirable place to live. Most people would say that Oakley is an “up-and-coming” neighborhood, but I would argue that most parts of Oakley are already at their peak, based on prices. Oakley is a neighborhood that is adjacent to Hyde Park (a very nice neighborhood which prices through the roof).
1243082_1 In this example I want to look at  multi-family properties.  I ran across some properties a while back– 4 units per building – asking $195k a building (5 buildings available).
I am going to calculate based off one building, then later take that scenario and multiple by it 5.
Imagine you get the building for $175k with 35k down. Assume a 7% commercial loan. Taking the numbers that the current owner claims to be getting for rent, and assuming 95% occupancy rate – We get the following results (click to enlarge):

Results

Go to the next page to continue the article

Hockey is Expensive

4538534881I became a newbie in the land of hockey, but boy hockey is expensive. It cost me roughly $800 to become involved with an adult league, not including gas and wear and tear on my car. You need a helmet, faceguard, stick, tape, hockey socks, jersey, shin-guards, elbow pads, chest piece with shoulder pads, skates, bag, and some other miscellaneous option stuff – it can get out of hand quickly.

So why would someone so frugal as myself decide to play hockey? Simple. I am 25 years old and I’m not going to get many more chances to become involved in a sport I wanted to play virtually my entire life.

I am completely inexperienced, and I do mean completely. I think I have about 8-10 hours of time on the ice with skates in my entire life prior to this journey. I have since completed two games with my Division 5-Lower team (lowest and newest player division). I am probably the worst player on the ice, but I’m just happy I finally got a chance to play.

Life is full of decisions and I knew that the older I got – the less likely I would become an active hockey player. Things come up later in life (children, job, physical limitations, etc.) that make a barrier to entry for hobbies that take as much dedication as hockey. I rolled the dice and put my money where my mouth is and I’m glad I did so.

Pandora (Symbol: P), A Falling Knife of a Stock?

pandora_logoPandora Media, Inc. (Symbol: P) has taken a giant hit in recent times from its 52-week high of $26 a share. Now even while trading for roughly $10 a share, it’s hard for me to justify buying into the stock.

Let me start out by saying, I personally use Pandora – a lot, but my overall usage has been on the decline – so I might be a bit bias. For those of you not familiar with Pandora, Pandora is a internet radio website that allows users to select artists they prefer to listen to and Pandora will then recommend more music (in addition to playing the selected artists) to the user based off an algorithm using the artists selected.

I would argue that Pandora was first to take this concept and really get traction with it, but they will not be the last. Since Pandora’s success there has been many companies and radio stations (such as Spotify, Sirius XM Radio, and even individual radio stations like iHeartRadio) that are determined to cash in on this service.

Before going any further – let’s talk fundamentals.

EPS: –$0.22
Market Cap: 1.62B
P/E:  N/A (EPS is negative)

Now let’s talk about What Pandora has going for it.

  • Pandora was the first to get traction
  • Pandora has a large audience
  • Pandora is now implementing more advertising (Which leads to more revenues)

But what about the downsides of Pandora.

  • More competition
  • Adding advertisements can lose audiences
  • EPS is negative
  • It’s very possible that Pandora was a trend, now on the decline
  • More people using online services such as Google Music

Final thoughts:

This stock is a hail mary, sure it could explode and be a giant player – but until they start showing profits it’s a fundamentally weak stock. I don’t personally have a large enough money to dabbing in this stock but I think anyone who had a substantial portion of their portfolio in this stock would be completely reckless. Could this stock be worth 5, 10, or 25 more than its currently valued at? Of course, but it also could never turn a real profit and spend away whatever it does make on development.  I foresee Pandora offering completely new services and expanding while it tries to turn a profit on its already existing services. I think this stock has a realistic chance of being on the decline unless they can should warranted profits soon.

Disclaimer: This an opinion only – Consult a professional financial advisor and assess all risks before investment.

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