An Investment Only a Mother Could Love: The Case for Natural Resource Equities

An Investment Only a Mother Could Love: The Case for Natural Resource Equities




by Lucas White and Jeremy Grantham, GMO

Executive Summary

•  We believe the prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources.

•  Public equities are a great way to invest in commodities and allow investors to:

•  Gain commodity exposure in a cheap, liquid manner

•  Harvest the equity risk premium

•  Avoid negative yields associated with rolling some futures contracts

•  Resource equities provide diversification relative to the broad equity market, and the diversification benefits increase over longer time horizons.

•  Resource equities have not only protected against inflation historically, but have actually significantly increased purchasing power in most inflationary periods.

•  Due to the uncertainty surrounding, and the volatility of, commodity prices, many investors avoid resource equities. Hence, commodity producers tend to trade at a discount, and they have outperformed the broad market historically.

•  While resource equities are volatile and exhibit significant drawdowns in the short term, over longer periods of time, resource equities have actually been remarkably safe investments.

•  By some valuation metrics, resource equities have looked extremely cheap throughout 2015 and the first half of 2016, and that may bode well for future returns.

•  Given the difficulty in predicting commodity prices, the low valuation levels of the past year and a half may be unjustified.

•  Despite all of this, investors generally don’t have much exposure to resource equities. Typically, they don’t have large specific allocations to resource equities, and the broad market indices don’t provide much exposure to the commodity producers. The S&P 500’s exposure to energy and metals companies has dropped by more than 50% over the last few years, and the same is true of the MSCI All Country World Index. Those investing with a value bias may be particularly underexposed to resource equities, as value managers tend to be especially averse to the risks posed by commodity investing.

 

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An Investment Only a Mother Could Love the Case for Natural Resource Equities(1)

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