Investing in Commodities: Five Lessons from the California Gold Rush

4. Enjoy the boomtown and escape the ghost town. To support the increased activity surrounding a commodity or industry, whole "ecosystems" are created. When the boom goes bust, those ecosystems are left to crumble.

During California's gold rush, whole towns were erected around "rich in gold" areas. These "boomtowns" were known for their striving businesses and overall activity. When the gold rush was over, those towns had no real viability and became "ghost towns."

As an investor, what you want to do is identify a "rush" or bubble and find companies that are building their business around it. A striking example of this (which ignores the previous gold rush lessons) is the range of new start-ups rushing to into gold exploration, driven by the record high prices of gold.

Dia Bras Exploration (ticker symbol: DIB, Toronto Stock Exchange) is an example of a short-lived company that does not have institutional memory of price decreases. It is worthwhile to watch it, and see whether they significantly increase their allocated resources for gold exploration. If they do, be ready to short them when you believe gold prices are going to fall, because they are likely to be stuck like the home builders in the U.S., with excess capacity that had cost too much to build.

5. The reliable money is in picks and shovels. During the gold rush, providing picks and shovels to dig the gold with, was more lucrative than the actual gold-digging. In agriculture, those are the equipment manufacturers (like Caterpillar (CAT - Cramer's Take - Stockpickr) and Deere (DE - Cramer's Take - Stockpickr)) and the chemical manufacturers (like Monsanto, Potash (POT - Cramer's Take - Stockpickr), DuPont (DD - Cramer's Take - Stockpickr)) who will make a lot of money selling more and better (higher priced) equipment to farmers flush with money.

Of course, the trick is to pick the likely winner within each category. To do so, you want to see which company is best positioned to capitalize on the growth in the space because it has the most upside potential in terms of products, global reach and cash to acquire other companies. However, instead of betting on one company -- which can provide higher returns, but more risk -- you can bet on the sector and "index it" (see index fund ).

The ultimate lesson from the gold rush is that because the "picks and shovels" manufacturers make money regardless of the short-term movement of commodity prices, there is much less risk in investing in them instead of the commodity itself.

All of these lessons apply only if you invest with a bit longer-term (several years) time horizon. In the short-term, randomness, and temporary fluctuations might have stronger effects than fundamental economics. I believe in investing according to fundamental principles, not beliefs in next day's values, or how the "die" may roll. Rolling dice is much more fun to do in a Las Vegas casino, where nearby, the huge falls in real estate prices attest to the folly of crowds and speculators.