The iron ore price has dropped from around US$90 per tonne to US$73 per tonne in the last month. Consequently, this has sent Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) down from their 2017 highs by 15% and 23% respectively.
If you managed to buy the resource companies back at the start of 2016 then you are still sitting on an impressive gain, but it goes to show how unpredictable commodity prices can be.
Warren Buffett has frequently told investors over the years that the best businesses to own are the ones that have a strong brand, economic moat and competitive advantage which allows them to increase prices year after year to little detriment.
Commodity businesses have no such pricing power. The price they can get for their product is entirely based upon the global market rate for iron ore, oil, or whichever other commodities they dig out the ground to sell.
The best businesses to own are the ones that can strongly compound the returns they achieve on money they keep in the business. Great examples of this are companies like REA Group Limited (ASX: REA), Ramsay Health Care Limited (ASX: RHC) and Altium Limited (ASX: ALU).
There are only a few ways that commodity businesses can increase sales and profit. They can reduce costs, but there are only so many cost reduction strategies that can be implemented. They can achieve a higher price for their product, but that isn't decided by them. Or, they can simply extract and sell more, but this usually has a detrimental effect on the price.
Foolish takeaway
I think the 'easy money' has been made on commodity companies already. The best an investor can hope for is a cyclical performance, which isn't my kind of investment.
