Carmel Fisher: The too-thrilling investment

From China to Australia, rising prices have been a welcome change for coal miners. Photo / AP

While I have never invested in mining stocks, I can appreciate the thrills investors in commodities experience when the cycle goes their way.

Anyone with an exposure to coal right now is enjoying a thrilling ride - though it has been a long time coming.

To the surprise of many, coal has enjoyed a stunning price rally this year, outpacing all other commodities. Metallurgical or coking coal is a relatively rare component of the earth's crust - much rarer than thermal coal and iron ore - and is used predominantly in steelmaking.

Despite coking coal's relative scarcity, its price on the world market has declined for five straight years from 2011 to 2015.

The metallurgical coal price turned positive in January and is up by more than 150 per cent year to date, catching analysts and producers unawares. Coal selling at $US72 a tonne in January is currently selling for $US186 and the price set for December is close to $US200 a tonne.

Coal is not "produced". Geological processes and decaying organic matter create it over thousands of years. It is mined from underground seams or tunnels, then cleaned and processed for commercial use.

This is one reason I've never liked investing in commodities - there is no way of adding value to a commodity.

A tonne of coal is a tonne of coal, regardless of where you extract it, how you extract it and what it's used for.

Its price is determined each quarter by major market participants who set a benchmark price based on supply and demand.

In the pricing process, participants such as Rio Tinto, Anglo American and Glencore consider things like global economic growth, short and long-term interest rates, operating and political risks, mine openings and closures, Chinese supply and global steel production.

It is virtually impossible to forecast with any certainty coal supply and demand, and therefore likely price trends. In 2007, the then Goldman Sachs CFO, David Viniar, described the challenge of investing in commodities: "It's a dangerous business to be in if you're not expert. It's a dangerous business to be in even if you are expert".

Another famous warning dates back to 1879, when Charles H. Dow (founder of the Dow Jones index) said: "Mining securities are not the thing for widows and orphans or country clergymen, or unworldly people of any kind, to own. But for a businessman who must take risks in order to make money, who will buy nothing without careful, thorough investigation and who will not risk more than he is able to lose, there is no other investment in the market today as tempting as a mining stock."

Careful, thorough investigation today might lead a businessman (or other interested investor) to jump on the coal wagon in the hope the ride continues.

According to experts, the coal price has risen because of limited supply as China's authorities have imposed reductions in Chinese coal production - to keep citizens in work and make their mining industry profitable. Meantime, Chinese coal demand for steel production is growing and needs to be satisfied.

The world's producers - especially those in Australia - are happy to oblige.

Given the extent of the coal price rally in 2016, some retracement is expected, though coal bulls are optimistic this might be the beginning of something big.

Thrilling as it may be, investors need to approach commodity investing with a steely nerve and eyes wide open.

We unworldly people might need to get our thrills elsewhere.