Natural resources investing: Meaning, Criticisms & Real-World Uses

What Is Natural Resources Investing?

Natural resources investing involves allocating capital to companies or assets involved in the exploration, extraction, processing, or distribution of naturally occurring materials. This approach to portfolio management falls under the broader category of asset classes. Investors typically engage in natural resources investing to gain exposure to commodities such as crude oil, natural gas, precious metals like gold, industrial metals, agricultural products, and timber. A primary motivation for natural resources investing is often its potential to serve as an inflation hedge, given that the prices of raw materials tend to rise during periods of increasing inflation. Additionally, this investment strategy can enhance portfolio diversification by introducing assets whose price movements may not be highly correlated with traditional financial assets like equities and bonds.

History and Origin

Investing in natural resources has roots as old as trade itself, but its formalization as a distinct investment strategy within modern finance gained prominence in the 20th century. Major global events, particularly periods of significant inflation and supply shocks, have historically underscored the importance of natural resources. A notable example is the oil crisis of 1973, when an oil embargo by the Organization of Arab Petroleum Exporting Countries (OAPEC) nearly quadrupled crude oil prices. This event, alongside other factors, contributed to surging inflation and economic uncertainty, highlighting the direct impact of natural resource availability and pricing on global economies.⁷,⁶,⁵ Such periods demonstrated how tangible assets could perform differently than traditional financial instruments, drawing investor attention to their unique properties.

Key Takeaways

Natural resources investing provides exposure to raw materials like energy, metals, and agricultural products.
It is often considered a hedge against inflation, as commodity prices can rise with general price levels.
Investing in natural resources can offer diversification benefits due to its low correlation with other asset classes.
Returns are highly sensitive to global supply and demand dynamics, economic growth, and geopolitical events.
Investment can be direct (physical assets) or indirect (stocks, mutual funds, or exchange-traded funds focused on natural resource companies).

Formula and Calculation

Natural resources investing does not typically involve a single, universally applied formula like calculating bond yields or stock returns. Instead, the valuation and potential returns from such investments are derived from various factors specific to each resource and the investment vehicle. For example, the valuation of a mining company might involve calculating its discounted cash flows, which are heavily influenced by projected commodity prices, extraction costs, and reserves.

For investors using commodity futures contracts, the expected return might consider the spot price, futures price, and cost of carry. The total return for a commodity futures contract can be broadly conceptualized as:

\text{Total Return} = \text{Price Return} + \text{Roll Yield} + \text{Collateral Yield}

Where:

(\text{Price Return}) represents the change in the spot price of the underlying commodity.
(\text{Roll Yield}) is the gain or loss from rolling over futures contracts before expiration, influenced by the difference between the expiring contract's price and the next contract's price.
(\text{Collateral Yield}) is the interest earned on the cash collateral supporting the futures position.

Interpreting Natural Resources Investing

Interpreting natural resources investing involves understanding its responsiveness to macroeconomic trends and specific industry dynamics. Prices of natural resources are highly sensitive to shifts in global economic growth, industrial production, and population growth, which directly influence demand. On the supply side, factors such as new discoveries, technological advancements in extraction, and regulatory changes can significantly impact availability. Investors evaluate the outlook for these underlying commodities, as their price movements drive the performance of natural resource investments. For instance, a strong global economy often leads to increased demand for industrial metals and energy, potentially boosting returns from relevant natural resource investments. Conversely, an economic slowdown could depress prices and returns. Understanding these interconnected dynamics is crucial for effective asset allocation in this sector.

Hypothetical Example

Consider an investor, Sarah, who believes that global inflation will rise over the next five years. To potentially hedge against this, Sarah decides to allocate a portion of her portfolio to natural resources investing. She researches various options and chooses an exchange-traded fund (ETF) that tracks a broad commodity index, including crude oil, natural gas, copper, and corn.

Initially, Sarah invests $10,000 in this ETF. Over the next two years, rising energy demand from emerging markets and supply constraints in certain agricultural regions lead to a general increase in commodity prices. The ETF's value, which mirrors the performance of the underlying [tangible assets], increases by 15%. Simultaneously, the broader equity market, which makes up another part of Sarah's portfolio, experiences moderate returns due to rising interest rates.

Sarah's natural resources investment serves its intended purpose by providing a positive return during a period of rising prices for goods and services, thus helping to preserve her purchasing power. While the specific returns are hypothetical, this example illustrates how natural resources investing can perform in response to anticipated macroeconomic conditions.

Practical Applications

Natural resources investing has several practical applications across various investment strategies:

Inflation Hedging: Many investors utilize natural resources, particularly broad commodity indices, as a direct hedge against [inflation]. When the cost of goods and services increases, the value of raw materials often rises, providing a counterbalance to the eroding purchasing power of cash or fixed-income assets. A 2023 Reuters survey of global hedge fund managers indicated a significant interest in commodities as a shield against persistent inflation.⁴
Diversification: Adding natural resources to a diversified investment portfolio can reduce overall portfolio [volatility]. Their historical low correlation with traditional asset classes like stocks and bonds means they may perform well when other assets are underperforming.
Growth Exposure: Investors seeking exposure to specific global growth trends, such as the increasing demand for certain minerals due to renewable energy transitions or urbanization, can invest directly in companies that mine or produce those resources.
Commodity Trading: Professional traders and institutions actively trade [futures contracts] and other derivatives based on natural resources to speculate on price movements or to manage price risk for producers and consumers.

Limitations and Criticisms

Despite its potential benefits, natural resources investing comes with notable limitations and criticisms. One significant drawback is its inherent [volatility]. Commodity prices can fluctuate wildly due to factors like weather events, geopolitical tensions, and sudden shifts in [supply and demand]. For example, a sudden disruption in oil production from a major producing region can send crude oil prices soaring, but an unexpected economic slowdown can cause them to plummet.

Another criticism centers on environmental and social concerns. The extraction and processing of natural resources often carry substantial environmental impacts, such as habitat destruction, pollution, and greenhouse gas emissions. Social issues, including labor rights, indigenous community relations, and resource governance, also frequently arise, particularly in the extractive industries. Organizations like the OECD emphasize the importance of [sustainability] and responsible business conduct in the extractive sector to mitigate these risks.³ Investors seeking to align their portfolios with environmental, social, and governance (ESG) principles may find direct natural resources investing challenging, necessitating careful due diligence on specific companies or funds. Furthermore, holding physical commodities can incur significant storage and insurance costs, while investing via derivatives requires understanding complex financial instruments.

Natural Resources Investing vs. Commodity Investing

While often used interchangeably, "natural resources investing" and "commodity investing" have subtle but important distinctions.

Feature	Natural Resources Investing	Commodity Investing
Primary Focus	Companies involved in the discovery, extraction, processing, and distribution of natural resources. This includes energy, mining, agriculture, and timber companies.	Direct exposure to the raw materials themselves, often through futures contracts or physically held commodities.
Exposure Type	Equity exposure to the companies that produce or manage natural resources. Returns are influenced by both commodity prices and company-specific factors (management, debt, operational efficiency).	Direct price exposure to the underlying raw material. Returns are primarily driven by the commodity's price movements.
Risk Profile	Subject to company-specific risks (e.g., operational failures, management issues) in addition to commodity price risk.	Purely exposed to commodity price risk, storage costs, and roll yield issues for futures.
Common Instruments	Stocks of energy companies, mining companies, timber REITs, agricultural firms, mutual funds, and ETFs focused on these sectors.	Futures contracts, physical commodities (e.g., gold bullion), commodity ETFs that hold futures, or notes linked to commodity indices.

The key difference lies in the level of remove from the raw material. Natural resources investing typically involves equity risk of the companies, offering a blend of industrial performance and commodity price sensitivity. Commodity investing, conversely, aims for a more direct correlation with the price movements of the raw materials themselves, often without the specific business risks of a company.

FAQs

Q: Why do investors consider natural resources investing an inflation hedge?

A: Natural resources, as raw materials, are essential inputs for most goods and services. When overall prices in the economy (inflation) rise, the cost of these raw materials often increases as well. By investing in them, individuals may see the value of their holdings increase, helping to offset the diminished purchasing power of their currency.²,¹

Q: What are some common types of natural resources to invest in?

A: Common categories include energy (oil, natural gas, coal), metals (gold, silver, copper, iron ore), agricultural products (corn, wheat, soybeans, livestock), and timber. Investors can choose to focus on broad categories or specific resources based on their outlook.

Q: How can an individual investor gain exposure to natural resources?

A: Individual investors can gain exposure through several avenues:

Stocks: Purchasing shares of companies involved in resource extraction or production (e.g., oil majors, mining companies).
Mutual Funds and ETFs: Investing in funds that specialize in natural resources or track commodity indices. These offer [portfolio diversification] within the natural resources sector itself.
Physical Commodities: Directly owning assets like gold or silver bullion, though this comes with storage and insurance considerations.
Derivatives: Using [futures contracts] or options, though these are typically more complex and carry higher risk.