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

by Lucas White and Jeremy Grantham, GMO

Executive Summary

ā€¢Ā  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.

ā€¢Ā  Public equities are a great way to invest in commodities and allow investors to:

ā€¢Ā  Gain commodity exposure in a cheap, liquid manner

ā€¢Ā  Harvest the equity risk premium

ā€¢Ā  Avoid negative yields associated with rolling some futures contracts

ā€¢Ā  Resource equities provide diversification relative to the broad equity market, and the diversification benefits increase over longer time horizons.

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

ā€¢Ā  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.

ā€¢Ā  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.

ā€¢Ā  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.

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

ā€¢Ā  Despite all of this, investors generally donā€™t have much exposure to resource equities. Typically, they donā€™t have large specific allocations to resource equities, and the broad market indices donā€™t provide much exposure to the commodity producers. The S&P 500ā€™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)

Copyright Ā© GMO LLC

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