Scarcity is an often-sought element of an investment. A limited supply of an asset is likely to prompt significant price rises as reserves become depleted. With most natural resources, there is a limited capacity for renewal.
Anything that is mined or collected in its raw form can be classified as a natural resource and forms the base of many of the products used in daily life. Trees may be turned into paper, precious metals into jewellery, crude oil into usable energy, and minerals into building materials.
As emerging markets continue to develop, demand for raw materials grows, which leads to higher prices that companies can charge for the materials, increasing profits. Developing countries have a particularly large appetite for materials to build infrastructure and transportation links, such as timber, steel, and gravel. Developed nations are not immune to the need for such materials as well, as populations continue to grow and put a strain on existing works, and a greater number of people are moving to cities. Some commodities, such as water, are always in demand.
Political motives can also stir demand for natural resources. Governments that are planning for expansion may start to buy up large quantities such as gold and silver, often viewed as safe haven assets when governments identify an increased risk of conflict or excessive inflation. Some countries may also try to take advantage of another country’s natural resources unfairly, or could attempt to make imports of these products cheaper by forming trade agreements.
Natural resources are not correlated with the performance of the other sectors, as consumption often must continue despite economic downturns, making this asset class a good diversifier.
Natural resources sector
While it may seem an intimidating asset class, especially to hold directly, funds that have a high allocation to natural resources can offer investors a more convenient way to gain exposure and add diversity to a portfolio.
The weighted performance of investment trusts in the Association of Investment Companies (AIC) Sector Specialist: Commodities and Natural Resources space on average over the past five years is shown in Graph 1.
The sector is trading on a 10 per cent discount to the value of the underlying assets, according to the AIC. This is in stark contrast to the average investment company discount of 4 per cent. Although there is variation in discount within the sector itself, meaning that advisers need to look at the specific companies the fund is invested in before recommending it.
