NOVEMBER 2010                                                                                            Download PDF Version
                                                                                                                              Download Professional Advisor Version

Natural Resource: Investing for the Cycle?                                              


A modified version was published in Professional Advisor magazine in November 2010

It is impossible to write about natural resources and commodities as a uniform asset since they are divided into a number of classes and sub-classes. I would separate them into ‘soft commodities‘ that are grown, ‘hard commodities‘ that are mined and ‘energy commodities’ that are combusted. For the purpose of this article I will not be discussing soft commodities. 

It is not too controversial to say that the planet’s natural resources are finite. Therefore, as long as a commodity does not suffer obsolescence, it can be assumed that as the supply gets scarcer the price will increase. However, over the short-term the use of commodities is linked to global growth and so prices move in an extremely volatile manner.


The Super-Cycle Argument

There is an oft-repeated argument that commodity prices move in cycles of 25 years. Furthermore it is claimed that the current commodity bull market started in 2000 and we are only half way through; the 2008/09 recession was merely a short interruption of a much longer trend.

The argument is compelling, with the industrialisation of China and India being the driving force. The facts and figures, just looking at China, are impressive. China uses half the world’s iron ore, 40% of the steel, aluminium and coal, is a buyer of 35% of global copper production and is the second biggest importer of crude oil. China also produces 95% of the world’s ‘rare earths’ and consumes 60% of this production.

China is also in the early stages of its industrialisation. By way of example China only consumes 1.7 barrels of oil per person per year; in industrialised economies this is 15 barrels per person per year. This growing demand is now coupled with a supply side that has either stalled, due the global slowdown, or has become constrained as the best reserves in the developed world have been exhausted.   

Investment Options

So how can the private investor play this commodity super-cycle?

The key considerations are that commodities not only have been one of the most volatile sectors but also that there are often different drivers behind each asset. If an investor wishes to invest in the ‘China story’ they should consider whether they wish to play it directly through commodities, which provide a more leveraged exposure, or through a more ‘plain vanilla’ equity or debt fund.  

If direct investment is preferred then the various assets need to be considered; the precious metals, the industrial metals, the energy resources or even the ‘rare earths’. Generally with the metals one can buy the physical commodity, an ETF linked to the commodity, a company involved with production of the commodity or a fund which invests in a diversified manner.

One of the best known commodity funds is the BlackRock World Mining Fund. However, with Rio Tinto and BHP Billiton being the largest holdings investors may prefer to buy these equities directly and avoid fund charges. There are specialist funds investing in smaller companies, but an investor will need to be sure they are comfortable with the increased risk of small caps.

With oil and gas there are similar choices of investment, although it is less easy to keep barrels of oil under the mattress. Funds have profitably invested in this sector; one of the best was the Consulta Canadian Energy Fund, which compounded at 18% for 20 years; sadly this fund is closed and at Clarmond we are now looking for its replacement.

Finally the ‘rare earths’, which have recently been getting press, most notably Molybdenum. An ETF has just been launched which shows how this asset class has ‘come of age’. However, these metals have rocketed in value, which has even led the CEO of Molycorp (the only ‘moly’ producer in the USA) to comment that prices were moving into a ‘bubble’. I would therefore advise clients to monitor the sector rather than rushing to invest.


Sleeping at night

At Clarmond we encourage clients to analyse their risk appetite honestly before investing in commodities. The large returns that can be made can be matched by substantial short term losses.

  1. If you want to play China there will be non-commodity ways to achieve this.

  2. If you want commodities with some protection there are structured products that will allow upside participation with limited downside.

  3. If you want diversified exposure and risk invest in the best fund or a portfolio of commodity equities.   

  4. If you want a leveraged exposure look towards the small-cap sector or the rare earths.

The decision remains with the investor, however, a good advisor should certainly be able to assist with the choosing not only of the most suitable commodities but also the most suitable investment vehicles.

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