Valuing Commodities

I would love to see an answer on this as well. I've never seen a good valuation technique on the underlying commodity. Anybody I've seen is mostly doing things based on the shape of the futures curve or technical analysis.

Regarding the currencies I mentioned: in general, investors view silver and gold as a preferent store of wealth when the value of the US dollar declines. So if you're anticipating the value of the dollar sharply rising, it'd be a good idea to unload your silver position, because, theoretically, you'd get more value from holding the dollar. Silver will often augment your returns in most porfolios, and gold investors will often hold 20-30% silver to supplement their gains. Just remember that the pendulum moves both ways, so a bad day in silver trading can fuck your portfolio up pretty hard.

There's much to be said re: the accuracy of the SLV ETF(a lot of investors/bloggers will tell you the asset values are way off), but I bet if you graphed it next to a few different commodities and currencies in terms of % returns, you would get a pretty good picture of its asset correlations, which is fundamental in valuing any commodity (especially one so volatile). Let me know what you find out dude.

Thanks for your detailed reply. Unfortunately this is the sort of reactionary qualitative speculation that I am trying to steer clear of. There has to be a better way... If you consider a commodity like an equity it's intrinsic value would be the revenue or cash it can generate less how much it costs to generate it. Although a little abstract, a commodity can be thought of in the same way. What's the value of gold? the $$ of 'happiness' less the cost of mining and refining. Wheat and other soft commodities? The sale price of the end product less the costs of production.

This delta between real 'production costs' and end sale price is the 'value' that is there to be split between all the people that do something to the commodity to get it from A-->B, right?

I feel like there has to be huge mis-pricings in this market caused my ill conceived economical outlook and projects rather than what it's worth now, and why...

You'd want to understand the underlying drivers of supply and demand for each individual commodity, and have an outlook on that. For instance, the biggest driver of demand for copper comes from Chinese exports, so you'd want to have an outlook on Chinese exports to have an outlook on copper. You could probably trace fundamental demand even deeper and dive into what Chinese product is the underlying source of the demand. Note that the elephant in the room people often miss when thinking about commodities is inventories, which complicate the picture somewhat.

However, I think you could argue that gold (and perhaps other precious metals) are better thought of as currencies, because, as CaR alluded to, it is often bought as alternatives to fiat currency. That is, unlike most commodities, demand for gold does not come primarily from its use in 'real' production (that's only a small part of the story).

since you said u want the intrinsic why not dig REALLY REALLY deep and actually find out how much cash flow an ounce of AG produces; for example; machinery costs 900$ (and contains some silver), and can produce xxx good at q quantity, that sells for yyy price, then figure out what yyy*q is and figure out the cash flow silver can generate, apply an approiate discount rate and figure out the break even cost that silver would have to be so the machine generates no profit. and silver should be valued somewhere around there

but obviously; this method has clear flaws and is impossible to do; good luck killing urself trying to figure this out

Notice you said whether you should "be buying," "be selling," etc. Some very subtle yet very important things you're mentioning here.

A few things. Most commodities players do not take outright positions by simply buying futures. Therefore, they'll have a more specific view, such as "wheat when compared to corn" or "August Wheat vs. September Wheat." Or, if they have assets and trade physical, long USGC crude, short NYH crude. Or something. Idk. You get the idea.

Therefore, the idea here is almost more like Asset Management than stock picking (tempted to delete this comparison so only try to get what I'm saying, I don't mean this exactly), in that you are trying to gain the appropriate amount of exposure to that commodity versus the other ones in your portfolio.

I would personally suggest saying you want exposure to wheat over corn (random example), because the supply/demand outlook for that is more favorable than the other, or something like that. I'm starting to ramble and my message isn't that clear so I'll stop here, but let me know if any part of that didn't make sense.

Basically, you are trying to take a stock picking approach, when in reality it might be wiser to think more like an asset manager or trader.

Edit: an instrument of speculation is true, but so is everything else. You're telling me stocks nowadays are driven by deep value? That's laughable. To ignore the outside factors just because you don't like them or you don't "bleed" them is stupid. Use your quant background to quantify the supply/demand characteristics. Use your head. Nothing more. People use futures for hedging, for spreads, for derivative strategies, and a lot more. It's not purely a speculative instrument, you just seem to be a bit unmotivated/stubborn in your effort to understand them.

ask the md brah

So I guess you look more for arbitrage in accuracy of information rather than a mispricing of the commodity itself. Are there leading indicators for any of the soft commodities? This, again, I understand is speculative but I'm more interested to look at the correlations in the number and drill down to see if there is really anything to it.

http://www.usda.gov/wps/portal/usda/usdahome?navid=DATA_STATISTICS if you wanna look up stuff for aggs. there are reports released periodically on crops and i'm sure it moves prices, but disclaimer i'm not a true aggs person.

if you have access to bloomberg, check out FDM and go to the aggs section - i am assuming those are the data points buy side speculators are paying attention to. bloomberg has a popularity gauge for those factors. hope this helps.

as op is quanty i'm guessing theres desire to quantify everything into a model. good luck predicting weather and droughts.

i think the guy who can hit up buddies in farms and commercial and knows why corn crop x isn't up to snuff for even feeding pigs in china will have the edge.

maybe you guys use adm rjo etc as broker? ask for research.

Here is my perspective like you I am mainly a value guy and fundumentals at the core. I think a deep value guy could be very important and useful in the commodity space, actually there is a series of guys who do just that and do very well. I think start by reading some of Barclays research is a good spot, they provide some of the best research and are always bottoms up, starting with fundumentals in my view.

I think each commodity is different like looking at each sector, different catalysts and key data points. But ultimately it all comes down to supply/demand. Typically what we do is build what we think is the current price "S/D" so what is the market currently pricing in our views, and then next we build what the true "S/D" should be. We build this out concurrently for each future time period, and one builds on the next, so for instance november picks up where october ends, december on where november ends. So if we see for instance price action is telling us in November the market will have 1000 widgets supplied, while demand is only 900 widgets. We know price action is wrong, and something needs to correct in that market place. What is the catalyst and needs to correct is where the same work ethic of a Burry style deep value guy comes, you find out that catalyst and track it nonstop.

PS, the above does not work for Silver/Gold/etc those are not commodities in my mind. Commodities are things people use and eat, nesscities of life. Gold/Silver are traded like currencies not commodities.