They're Hedged, Stupid. Schweser V1 E2 Q34

Schweser V1 Exam 2 Afternoon Test- Q34, the WTF item set.

“He feels that using the indirect method of buying the stock of those companies to gain commodity exposure is an efficient and effective method for gaining exposure to commodities. This is not necessarily true because those companies often hedge their exposure to commodities”

So, a company is established. It is commodity oriented. They mine gold from teeth in a graveyard, or produce methane from piles of bulls sh&t. They brought teams of field experts from Commodostan. And at the end, their returns are not “necessarily” exposed to commodity because they’re iFFING Hedged. Then why bother from the beginning? Why they don’t just trade Treasuries? I’m Fed up (and Bundesbank up) from long long long chain of production, management, hedging, FX exchange,etc; all to gain at the end the risk free rate. Talk about value added.

Am quitting investment and becoming a farmer. I’ll hedge my tomatoes by Yoghurt Protected Greece Government Bonds.

The perfect benchmark for both an African gold production firm in a war torn country during a commodity boom and a market neutral hedge fund staffed with oddles of Ivy league quants and billions in AUM: the risk free rate.

Once again, great rant.

Gold farmers hedge to protect a loss in value, they’re still making money from selling gold but they don’t participate in rallys and not rallys. Why anyone would construct a complex box spread to earn the risk free rate is beyond me

This is a pathetic Schweser exam, trust me. Just forget this one and move on.

I will note that out of everything to get wrong on this test, this isn’t one of them. Equities are an inefficient means of investing in commodities, they really hammer that point home.

Schweser mock is pretty bad, but this one is in the curriculum. Be thankful that Schweser tested you on this one first.

“…to gain commodity exposure is an efficient and effective method…”

Efficient and effective… Definitely not what miners are.

Haha yeah, anything but right?

It’s not about Schweser or CFA. It’s about the logic by itself. Why specialized companies are established while at the end they don’t have exposure to the very field they work in? Airways are not affected by fuel? Insurance companies are not affected by natural disasters? Healthcare is not affected by demographics? Yes there should be risk mitigation measures implemented. But to imply that these risk management tools reduce the exposure to the core business to an insignificance level is beyond me. If they’re hedging 20% of the exposure, then still those companies have a significant 80% exposure. If they’re hedging 80%, then we can say they have no exposure to their line of business. In this case they’re as good as Treasuries. So why waste all the efforts?

I get the CFAI exam doctrine. I’m just not getting the practices of such companies. A CEO, pays premiums out of his income to hedge his line of business. What an easy job. If things go up, cash in a bonus for performance. If things go down, cash in bonus for protection against losses.

Carly Fiorina wanna be the President of the USA, hedge that.

That’s just the thing. A company who mines for gold or provides a commoditzed service is not a speciality company, they’re providing a market service at a rate the market determines. The only thing that makes them money is by operating slightly better than their peer group or government subsidizes their profit margins.


Also keep in mine when they say hedged they mean the top line is hedged not the cost side. If they can control their costs and hedge their revenue away then they’re effectively locking in profit spread. The hedge prevents upside/down exposure, like you stated, which makes it a poor choice for investors seeking exposure to their commodity.

^Good explanation Galli.

But still, I think commodities affect prices/returns of those companies a lot.

You’re close to Shale Gas market. You noticed the exposure of oil prices on Shale gas and tight oil companies. The effect even extends to drilling and fracking operations.

Similar issues with timber companies, corn and soy beans farms, rear earth metals, and what have you.

Gold mines, I think you are thinking Europe and the US, while I was thinking Africa. In Africa the mines are operated and licensed to Russian and Chinese,… ummm,… “companies?”. So if they’re services companies, then they’re services companies.

I hope mine was an intended pun. What you’re saying is exactly why I don’t generally invest in miners (and haven’t been exposed to E&P’s either, though contemplating it). Remember from level 2 porter’s 5 - they are price takers and they operate independently. It’s hard for a business like this to consistently generate capital, and even harder to consistently reinvest in their business - so hard that major oil companies actually farm out the reinvestment! Looking to make money on gold by buying a company that may mine gold reserves in 3 to 5 years is a stupid proposition - there are better ways to make money in the markets, and better ways to get exposure to metal price fluctuations.

^ You got the pun :slight_smile:

To add on the back end of you comments, there’s been research done on mining ROE which has been shown to be negative over the long run. That’s right, it bleeds equity over time.

On top of that, in the long-run the marginal cost of production roughly equals their marginal revenue from production. It’s a total lose-lose situation, add in geopolitical risks, taxes, environmental impacts…

The only thing I invest into is the hyper speculative exploration companies. basically a long option on the underlying commodity with significant leverage to a small chance of an equity return.

For post-exam research - this might be an interesting pick for you

I don’t know if anyone else is addicted to the market, but I am just itching to get back to it once this fucking exam is over