Thread by @AgustinLebron3

1/ Quick mini-thread on a useful way to think about risk based on a recent discussion I had.

"If I have an opinion about lithium price, should I trade $LIT?"

2/ Almost definitely not. $LIT is a very weird monster. Many ETFs that target second-tier commodities are equally weird. Why?

Because $LIT includes both producers and consumers.

3/ High Li prices are good for producers, bad for consumers. So what's the effect on $LIT?

It depends on the balance of producers and consumers.

4/ 12% $ALB. They produce Li chemicals for batteries. Producer or consumer? Not clear.

5.9% Ganfeng Lithium. Producer.

4.7% $TSLA. Consumer.

Etc. It's very confusing.

5/ So let's develop a general model for resource stocks.

We can think of a resource stock as an arbitrageur. They arb the price of their inputs against their outputs.

This is true of business in general, but it's an especially useful model for resources.

6/ A gold miner arbitrages the price of gold with the cost of extracting it from the ground.

7/ A refiner is even more clearly an arbitrageur. They transform oil into gasoline (and other refined products).

If they can make that transformation more cheaply than the crack spread (gas - oil) they make money. Else they don't.

8/
- Airlines arbitrage kerosene into seat-miles.
- Farmers transform gasoline into soft commodities.
- Food companies transform soft commodities into consumer food. Etc.

9/ Want to put on a trade in lithium? You need to answer the question:

What systematic mispricing in either the:

- inputs (the cost of mining) OR
- the outputs (the price of lithium)

have you identified?

10/ If it's the output then you're better off just trading the commodity.

If it's the difference between the inputs and the outputs then you should think about trading the company's stock.

Or get into the business yourself!

/END