Natural Resources

Summary:
•    Natural resources can add portfolio diversification and stability
•    Natural resource stocks are a good option and…
•    appear historically under-weighted and undervalued


The Case for Natural Resources Equity Investments
Natural resources are things like corn, cattle, wheat, coffee, iron ore, copper, natural gas, timber, oil, silver, and gold. They are sometimes consumed directly, as food and gasoline are, and they are also important inputs to the economic processes that create goods and deliver services. As input prices rise, the economic profit usually decreases in an economy. To use a very simple example, if a bakery must pay more for wheat flour and is unable to raise prices by a corresponding amount, the bakery’s profit will decline. Therefore, it follows that resource prices can often move inversely to the general economic ebb and flow. 

Unlike financial assets like stocks and bonds that derive their value through a combination of expected cash-flows and the interest rate at which those cash flows are priced, natural resources are valuable in and of themselves. While often volatile, with significant gains and losses in the short term, this inherent value leads to price stability and reduced risk over longer periods of time. 

By investing in companies that produce, harvest, manage, or conserve natural resources we can gain stock market returns (the equity risk premium) while also obtaining the diversification benefits of the natural resources themselves. The following charts from GMO show the long-term diversification benefits of including resource equity investments in an investment portfolio (Note: These charts specifically refer to energy and metals stocks due to the availability of long term historical data for these specific types of resource equities. Public investment options in agriculture equities have only recently become more widely available, but similar conclusions apply):

Despite these noteworthy portfolio benefits, investors generally do not have significant natural resource equity exposure. In recent years as commodity prices retreated, both the US S&P 500 and the global MSCI ACWI stock market index exposure to energy & metals dropped by more than 50%: 

However, current valuations of natural resource stocks are near 90 year lows when compared to their general stock market brethren:

In summary, natural resources can provide excellent diversification for investment portfolios and currently appear under-weighted and undervalued by many investors. By including these types of investments as specific asset classes and increasing our allocation to them, we may improve our long-term portfolio stability and return.


Reference:
White, Lucas. Grantham Mayo Van Otterloo & Co. LLC. An Investment Only a Mother Could Love: The Case for Natural Resource Equities. 2016. www.gmo.com

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