Inflation has become a major concern for investors over the last few years. Especially as the European crisis escalates to a point of near catastrophic proportions, investors have begun pouring their funds into tangible materials so as to prevent their portfolio from deteriorating in the face of real value.
Unfortunately, these commodities are also losing value at the same time due to the decreased tangible demand for their usage to fuel growth in debt ridden countries. The end result is a question pertaining to where it is that an investor can put their money so as to realize the value of these commodities, without facing the capital depreciation risks associated with deflation. The trick to doing this is to understand how it is that the companies that interact with these commodities create value, and at what points of the economic cycle we want to place our money either into our out of them.
Commodity extraction and production companies have a great deal of their intrinsic value tied to the price of the product that they provide for the markets. However, because of the nature of their operations, they will continue producing tangible value for investors in different ways, despite the pricing trends that support their product. This is because of the way in which these companies will continue to operate and produce cash even during periods where the commodity prices are at low points. In actuality, it is during these low price periods in which the producing companies will actually create a great deal of value in terms of developing their asset bases, because they are able to do so very cheaply.
As a commodity producing company, low commodity prices mean that your purchasing power has increased. Specifically, this means that your ability to purchase land and resources which you can convert into a product will be much less than it has been previously due to the favorable price points.
This means that the company is able to gain more value from the funds it has earned in the past from higher rates of return, and invest them into improving their asset base. This will actually improve the tangible value of the company, and protect it from long-term inflation, as it usually means that the company will be holding great deals of land. From there, an investment into and commodity company in a downturn will also produce cash flows that help to support the fixed costs required to maintain all of these fixed investments.
The end result is that these companies are in very valuable positions in comparison to high-growth cycles, where the commodity prices will drive up revenues. From there, we can begin to analyze how it is that the value proposition of these companies changes during different economic periods.