Natural Resources easy

Natural Resources

• Natural resources include raw land, land for crops or timber, and commodities.
• Investment can be direct or through commingled funds like ETFs, REITs, limited partnerships, and LLCs.
• Commodity futures and swaps are commonly used derivatives for this asset class.
• Raw land, farmland, and timberland are illiquid; location primarily drives their value.
• Proximity to transportation, markets, water access, and soil quality increase the value of farmland and timberland.
• All three land types can generate lease income and price appreciation.
• Farmland and timberland generate income from output.
• Individuals primarily hold farmland, while institutions invest in raw land and timberland.
• Timberland lots are larger than farmland and require specialized expertise.
• Timberland investment management organizations (TIMOs) are available for investors lacking expertise.
• Farmland and timberland have fewer financing options than residential and commercial real estate.
• Financing is often through bank loans or direct private debt.
• REITs in farmland allow retail investors access to this category.
• Timber harvesting is based on current prices and expected growth rates.
• Farmers use short positions in commodity futures to hedge harvests due to commodity price fluctuations.
• Agricultural crops consume carbon, making them attractive to ESG investors focused on climate change.

Commodities

• Major sectors include metals, agricultural products, and energy products.
• Commodity contracts are also classified based on grade and delivery location.
• Governments may subsidize food crops or support farmers' prices.
• They may control access to natural resources or be directly involved in production.
• Climate change regulations may decrease fossil fuel demand and increase demand for minerals like lithium, cobalt, and nickel.
• Futures are more commonly used due to it being challenging to invest directly in commodities.
• Commodities have costs for storage and transportation.
• Futures, forwards, and options on futures are available commodity derivatives.
• Futures trade on exchanges, eliminating counterparty risk.

Other Methods of Commodity Exposure

• Exchange-traded products (ETPs) include exchange-traded funds (ETFs) or exchange-traded notes (ETNs).
• ETPs are suitable for investors limited to buying equity shares.
• ETFs invest in commodities or commodity futures and track prices or indexes.
• Managed futures funds, like commodity trading advisers (CTAs), are actively managed.
• Some managers focus on specific sectors, while others are diversified.
• Managed futures funds can be limited partnerships with hedge fund-like fees, restrictions on investors' net worth/liquidity, or mutual funds with publicly traded shares.
• Mutual fund structure offers lower minimum investment and more liquidity than limited partnerships.
• Separately managed accounts (SMAs) are for larger investors needing custom portfolios.
• Specialized funds focus on commodities like oil and gas, grains, precious metals, or industrial metals.

Commodity Valuation

• Wheat today differs from wheat six months from now.
• Buying today allows immediate use, while contracting for future delivery avoids storage costs and tying up cash.
• The futures price is approximately the spot price adjusted for the risk-free rate, storage costs, and convenience yield.
• Convenience yield is the nonmonetary value of having a physical commodity for use.
• Contango: futures prices exceed spot prices due to low convenience yield.
• Backwardation: futures prices are less than spot prices due to high convenience yield.
• Contango decreases returns for long-only investors, while backwardation increases them.

Commodities Prices and Investments

• Spot prices reflect supply and demand.
• Demand is affected by the commodity's value to users and global economic conditions.
• Supply depends on production, storage costs, and existing inventories.
• Many commodities have inelastic short-run supply due to long production lead times.
• Commodity prices can be volatile when demand changes or supply shocks occur.
• Weather and plant disease significantly affect agricultural commodity production.
• Extracting oil and minerals becomes more expensive as methods become costly or as more remote areas are used.
• Commodity producers analyze economic events, government policy, and supply forecasts to estimate future needs.
• Investors analyze inventory levels, production forecasts, policy changes, and economic growth expectations to forecast commodity prices.
• Commodity returns and volatility have recently been higher than global stocks or bonds.
• Timberland and farmland have higher average returns but lower volatility than global stocks.
• Speculators can earn high short-term returns when correctly predicting commodity price movements.
• Commodity returns have historically had low correlations with global equities and bonds.
• Adding commodities to a portfolio can provide diversification.
• Holding commodities can hedge inflation risk because commodity prices tend to move with inflation rates.
• Commodity prices are sensitive to geopolitical and weather-related risks.