The law of supply and demand

How much oil will people consume next year? How many iPhones will people buy? How many movies will people go to?

These are the types of questions many investors rely on in deciding what makes a good investment. But can you spot what those questions all have in common? There’s a little something hidden in there that tends to trip up budding Buffetts.

Look closely and you’ll find that each of those questions is focused on predicting demand. The last time I checked it’s incredibly hard to figure out where and how people will want to spend their money in the future. But as you already know, it’s called the law of supply and demand, not the law of demand. And it turns out that one of these things is much easier to guess than the other.

I don’t know how much oil will get consumed, but we can get a good estimate of how much oil will get produced.

I don’t know the whims and wishes of iPhone buyers, but we can figure out how many iPhones will get made.

I don’t know how many movies people will watch, but we can find out how many movies theatres will be open for business.

The supply is easier to understand because it deals with the here and now. For big businesses and industries, the supply tends to change much more slowly than demand. Based on the limits of production, service standards, and supply chains, we can’t all of the sudden make more oil appear, or movie theatres open, or even produce 10 million new iphones overnight (as much as Tim Cook would love otherwise). So by focusing on supply, we have a steadier barometer for what the marketplace is able to bear (without having to guess what it wants).

A similar concept is at work with financial capital as well. When you see a lot of money being raised (supplied) in a particular sector, it’s doubly important to keep an eye on how much new production will be coming online. Flooding the market with new supply is rarely a good thing for prices. On the other hand, when you see capital leaving a sector or plants and machinery being shut down, it usually means supply is coming offline, and financing being withdrawn. That’s one of the reasons we often hear that the cure for low prices is low prices.

Following the trend of supply instead of trying to predict the vagaries of demand can help investors better understand the risks to their companies through the capital cycle. 

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.