Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / Why Stock Pickers Overlook Commodity Cycles
Transcript
- Lucas: We’ve spent a lot of time talking about top-down macro signals, but today I want to drill into something that quietly kills more portfolios than any Fed announcement: the silent margin crush from commodity cycles. It’s September ninth, two thousand twenty-six, and while everyone is watching the S&P five hundred hover near seven thousand six hundred, the real story is happening in the cost of goods sold for half the companies in that index. Luna: You mean the fact that even if revenue looks fine, the underlying profitability is rotting because copper and energy costs just won’t stop climbing? Lucas: Exactly. Let’s look at the data on the desk. Apple dropped three point four percent over the last five days, trading around three hundred thirteen dollars. On the surface, it’s a tech stock, insulated by software services. But look closer at the hardware side. The bill of materials for an iPhone hasn’t changed much in design, but the input costs for rare earth elements and precision metals have surged. If you’re buying Apple as a pure consumer discretionary play, you might miss that they are absorbing massive commodity inflation without passing it all on yet. Luna: But doesn’t Apple have such immense scale and bargaining power that they can shield themselves better than smaller peers? Lucas: They certainly try, and for years they’ve been masters of this. But here’s the trap: when commodity moves are structural rather than cyclical, even giants get squeezed. Consider Berkshire Hathaway, up slightly to five hundred seven dollars. Warren Buffett has long warned about the hidden tax of inflation on business owners. When the price of steel, aluminum, or oil moves against you, your free cash flow shrinks not because you sold less, but because you paid more to make what you sold. This isn’t just about oil majors benefiting; it’s about every manufacturer losing ground. Luna: So you’re arguing that we should be shorter on industrial stocks that rely heavily on raw inputs, regardless of their brand strength? Lucas: I’m saying we need to audit our portfolios for commodity exposure. Take JPMorgan, trading at three hundred fifty-five dollars. Banks don’t buy copper, but their loan books are filled with industrials and retailers who do. If those borrowers’ margins compress due to input costs, credit quality deteriorates. The risk is second-order but real. Meanwhile, look at ExxonMobil, down a fraction to one hundred sixty-three dollars. Everyone assumes higher oil prices automatically help them, but exploration costs and equipment purchases also rise with commodities. It’s a complex feedback loop, not a simple linear benefit. Luna: That’s a nuanced view. Most people just see red numbers on their utility bills and assume energy stocks are a safe hedge. Lucas: It’s a dangerous assumption. Let’s talk about specific sectors. Packaging companies, for instance. They use paper pulp and plastics. When resin prices spike, their gross margins get hammered. Yet, their stock prices often lag because investors focus only on volume growth. I looked at a few mid-cap packaging firms recently, and their guidance was cautious not because demand was weak, but because they couldn’t secure long-term contracts at stable prices. That’s a classic commodity cycle signature: volatile inputs meeting rigid output contracts. Luna: And that rigidity is what creates the mismatch between reported earnings and actual cash generation, right? Lucas: Precisely. You report strong sales, but your cash conversion cycle breaks down. You’re paying suppliers more upfront or accepting worse terms because they know you’re desperate for materials. This liquidity crunch is invisible on an income statement until it hits the balance sheet. Look at Centerspace, a real estate investment trust focused on self-storage. Their operating costs include significant fuel and maintenance supplies. Even though REITs are generally viewed as interest-rate plays, their operational expenses are tied to commodities too. A ten percent rise in diesel prices eats directly into distributable cash flow. Luna: I hadn’t connected self-storage operators to diesel prices before. That’s a sharp observation. Lucas: It highlights how pervasive this issue is. Now, let’s pivot to the positive side. Some companies actually thrive in high-commodity environments. These are the ones with vertical integration or unique sourcing advantages. For example, certain mining equipment manufacturers see orders surge when miners expand production to meet rising metal prices. But even then, the timing matters. If you buy the equipment maker after the capex cycle peaks, you’re buying at the top of the commodity wave. It’s all about the phase of the cycle. Luna: So the key is identifying where we are in the commodity supercycle. Are we near the peak or still building momentum? Lucas: Data suggests we’re in a late-stage expansion for some metals but early acceleration for others. Copper, for instance, is critical for electrification and grid upgrades. Demand is structurally higher than it was five years ago. Supply constraints from aging mines in Chile and Peru aren’t going away quickly. This means copper prices may stay elevated longer than traditional cycles predict. Companies that have locked in low-cost supply chains now hold a massive competitive moat. Those that haven’t are essentially subsidizing their competitors’ R&D departments. Luna: That makes me think of software companies again. Do they really escape this entirely? Lucas: Not entirely. Data centers consume enormous amounts of energy and require specialized cooling systems with expensive components. Microsoft, trading near four hundred ninety-three dollars, is investing billions in AI infrastructure. While their core product is software, the physical layer of that infrastructure is deeply tied to commodity markets. If electricity prices soar or semiconductor materials become scarce, their capital expenditure efficiency drops. They have the cash to absorb shocks, but their valuation multiples reflect perfection. Any stumble in execution due to input cost volatility gets punished harshly. Luna: So even tech isn’t immune. It’s just delayed exposure compared to industrials. Lucas: Exactly. Tech has a buffer because its marginal cost of replication is near zero. But the fixed costs of running the empire are skyrocketing. This brings us to a crucial point for stock pickers: you must separate operational excellence from favorable commodity tailwinds. A company might look like a star because it benefited from cheap oil during a downturn. But if oil stays high, does it still perform? That’s the stress test. Luna: And that stress test is exactly what separates serious investors from trend followers. Lucas: Right. So, before we go further, I want to pause for a moment. Our conversations here are designed to give you clarity in a noisy market. If these insights have helped you refine your own approach to investing, we’d be grateful for your support. It helps keep the show independent and ad-free. You can find us at buy me a coffee dot com slash fexingo. It’s a small gesture that makes a big difference in keeping this content going. Luna: Thanks for considering it. It really allows us to dig deeper into these nuances without compromise. Lucas: Back to the strategy. One way to position yourself is through diversification within the portfolio. Don’t just hold one industrial giant. Hold a basket of companies with varying degrees of commodity sensitivity. Some might be hedged via derivatives, others might have pricing power, and others might be vulnerable. By mixing them, you reduce idiosyncratic risk. Think of it like building a bond portfolio with different durations. You’re managing interest rate risk here by managing commodity risk. Luna: That’s a great analogy. It’s about duration matching for raw materials. Lucas: Spot on. Another tactic is to look at substitution effects. When steel becomes expensive, engineers switch to aluminum or advanced composites. Companies that lead in material science innovation can capture new margins. Tesla, for example, has been working on reducing rare earth usage in motors. If they succeed, they gain a cost advantage that rivals can’t match. This is where technological alpha meets commodity beta. It’s not just about riding the wave; it’s about changing the boat. Luna: So innovation acts as a hedge against input cost inflation. Lucas: Precisely. And finally, watch the inventory cycles. In a rising commodity environment, companies often build up inventory hoping prices will stabilize. But if prices keep rising, that inventory becomes a liability on the balance sheet, requiring more working capital. Cash flow dries up. Look at Casey’s General Stores, which saw movement today. Convenience store operators face rising food and fuel costs. If they can’t raise prices fast enough, their traffic might drop. It’s a delicate balancing act between passing on costs and maintaining volume. Luna: It sounds like the margin squeeze is universal, but the ability to adapt is the differentiator. Lucas: Absolutely. Your job as a stock picker is to find those adapters. Look for management teams that communicate clearly about input costs, show disciplined hedging strategies, and demonstrate pricing power in their sector. Avoid those that treat commodity spikes as temporary anomalies when the data suggests otherwise. In this market, ignorance of the physical world is a fatal flaw for financial analysis. Luna: So, grounding your thesis in the real economy is just as important as looking at the P/E ratio. Lucas: It’s essential. We’ll leave you with this thought: next time you analyze a company, ask yourself what it takes to make their product. Not just the code or the service, but the atoms and energy behind it. That’s where the true value—and the true risk—lies. Luna: A powerful reminder to look beyond the spreadsheet and into the supply chain. Lucas: Thanks for listening. Until next time, keep digging.