Natural Resource Investing

The reasons to invest in natural resources have always been compelling. Whether it's lumber, coal, or gold, natural resources are at the core of production. The screen you are using to read this article is just a collection of natural resources that have been processed and reprocessed. The pool of investable natural resources is growing as the world population requires more and more of these resources. In this article, we'll look at why you might want to consider natural resource investing and how to go about it.

The Scope of Natural Resource Investing

Natural resource investing has a broad scope that covers anything mined or collected in raw form. Starting with their raw form, natural resources may go through further processing – say, cutting a tree into 4x4s, 2x10s, 2x4s, and so on – or simply be cleaned up, packaged, and sold (a barrel of oil or a bottle of water). Natural resource investing overlaps with more specialized types of investing, including oil and gas investing, precious metals investing, minerals and (base) metals investing, etc. If it can be mined, cut, or collected from above or beneath the earth's crust, natural resource investors look for a way to buy-in.

One caveat, however. Agriculture – as in cattle, corn, cotton, et al – is often lumped in with natural resources because many natural resources and agricultural commodities are traded via the same methods. For the purposes of this article, agriculture is not grouped with natural resources, even though its outputs (grain, corn, etc.) trade just like other natural resources, and face similar economic forces. The reasoning is that many agricultural products are less durable than the rest of the group, making them questionable stores of value.

Reasons to Invest in Natural Resources

There are a number of reasons why natural resources make attractive investments now and in the future:

• Rising incomes: as incomes increase in developing countries, the demand for precious metals, building materials, and other natural resources tends to increase as well. Although a supply shock is still a potential risk with many resources, such as oil, rising demand generally leads to rising prices;
• Global infrastructure and repair: developing countries have a huge appetite for gravel, lumber, steel, and other materials needed to build roads and other public works. This building spree is being prompted by population growth and increasing urbanization. Similarly, much of the infrastructure in developed nations require updating on a regular basis, and the more decades that pass before repairs and updates are made, the larger the eventual spending will be;
• Political buying: a number of nations have begun buying up natural resources to ensure a consistent supply of crucial raw materials. This buying sometimes takes the form of political agreements and sometimes outright open market orders or foreign acquisitions, making governments another driver of demand;
• Store of value: many natural resources act as a store of value, particularly metals. These resources become more attractive when inflation threatens investors.

There is also an argument that natural resources have a low correlation with the financial sector. This is broadly true, as many companies continue to hold consumer natural resources investments well into a financial downturn, in hopes of being well-positioned for a rebound. However, as more and more of the activity in natural resources is being driven by investment and speculation, this lower correlation is likely to turn into a higher one.

Investment Options for Natural Resource Investors

So, you've heard the reasons, and are wondering where to start. Fortunately, a broader range of investment options is available than ever before.

• Direct investment: investors can always buy a resource directly. This approach works well for smaller investments in precious metals, but it quickly becomes impractical when speaking about timber, natural gas, and other resources that require large storage facilities, which come with associated costs;
• Futures and options: the contract-based approach to trading resources allows investors to leverage their dollars in a shorter time frame than storing a physical resource for months and months on end. These are great investments for experienced traders, but futures and options can be baffling to all but these specialists;
• Exchange-Traded Funds: natural resource ETFs are just another example of how ETFs can help an investor gain broad market exposure with just a few investments. Natural resource ETFs all contain a different flavor of what they consider essential, so finding the right one can take some looking. The good news is that there will likely be one that fits your exact needs waiting for you to find it;
• Stocks: ETFs are, of course, made up of stocks. Investors can cut out the middleman, and buy these natural resource company shares directly. These include mining stocks, forestry stocks, oil exploration stocks, etc. Generally speaking, there are two types of natural resource companies: majors and juniors. Majors offer a diversified play from extraction to processing to market sales, with possibly a dividend to boot. Juniors are a pure-play, and very sensitive to price movements. They usually offer no dividend, but can serve up large returns if the natural resource they control increases in value.

The Bottom Line

Natural resource investing is expanding. In the 1970s and even the 1990s, you couldn't easily make an investment in water. You would have to figure out which companies received a significant amount of their revenue from water, and then buy them. Now you can cut out those steps with Invesco Water Resources (PHO), among other ETFs. In other areas, the change has constituted simply a further increase in choice. You can still buy shares in a coal mining company or buy coal ETFs, trade coal futures, or even buy a shipment of coal to store; there are very few limitations to natural resource investing. With the choice of investments and the demand for these resources increasing in step, this is a very intriguing area for investors.