While many people call themselves “investors”, you don’t often hear people referring to themselves as “speculators”. What’s the difference?
We view investing (fundamental investing that is) as the exercise of putting capital to work with the objective of increasing the value of capital over time. This is achieved by buying something at a price below its intrinsic value with the view that the intrinsic value will continue to increase over time. While investors can debate all day what intrinsic value is, the underlying premise is the same – buy something for less than it is fundamentally worth today, with time being on your side as the value grows.
Speculating is a different animal. We view it as the activity of buying something with the hope of selling it for a higher price to another buyer – irrespective of intrinsic value.
While it is tough to argue with the logic of selling something for a higher price, without the fundamental value behind it, the risk of losses arguably increases. Buying a $20 bill for $18 is a good bet. Buying a $20 bill for $22 hoping to sell it for $25 could work, but it is hardly a low risk or repeatable strategy.
Fundamental investing sounds logical and easy enough, it requires patience, discipline and hard work (and even then we find ourselves making our fair share of mistakes). Discipline is particularly important in periods where speculation or momentum is in full force. We believe, however, that staying true to a fundamental and valuation driven process is the best way to protect and compound capital over the long term.
While there can be a grey area between fundamental investing and speculation, sometimes it is very obvious. Here are a few interesting examples of clear speculation in the market. I am showing these because speculation can move markets, which can also create opportunities for fundamental investors.
In early May, Chinese commodity markets experienced volatile moves driven in part by individual investors. Here are some interesting facts from Bloomberg:
- Enough cotton was traded in a single day to make a pair of jeans for every person on earth.
- Enough soybeans were traded in a single day to make 56 billion servings of tofu.
- More than 40% of volume in rebar futures happened at night (when retail investors are home from work.)
- The average holding period for rebar and iron ore contracts was under 3 hours.
In our minds, you can call this speculation (or gambling)! And while these people could be having fun and making money, it should not be confused with fundamental investing. If you are looking to gamble, you may want to stick to the casino. At least there you know the odds aren’t in your favour and you can get free drinks.