Natural Resources hard

• Natural resources include raw land, land for crops/timber, and commodities.
• Natural resource investment can be direct or through funds like ETFs and REITs.
• Derivatives such as commodity futures provide exposure to this asset class.
• Raw land, farmland, and timberland are illiquid with value driven by location.
• Proximity to transportation, markets, water access, and soil quality enhance the value of farmland and timberland.
• Farmland and timberland generate lease income, price appreciation, and 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.
• TIMOs allow investors without expertise to invest in timberland.
• Farmland and timberland have fewer financing options compared to residential or commercial real estate.
• Financing often comes as bank loans or private debt.
• Farmland REITs enable retail investors to invest in this category.
• Timber harvesting decisions are based on prices and growth rates.
• Farmers use commodity futures to hedge harvests.
• Agricultural crops consume carbon, appealing to ESG investors focused on climate change.

Commodities

• Commodities are divided into metals, agricultural products, and energy products.
• Commodity contracts are classified by grade and delivery location.
• Governments may subsidize food crops or control natural resource access.
• Climate change regulations may decrease demand for fossil fuels and increase demand for lithium, cobalt, and nickel.
• Futures are more commonly used than direct investment in commodities.
• Physical commodities incur storage and transportation costs.
• Futures, forwards, and options on futures are available commodity derivatives.
• Futures trade on exchanges, eliminating counterparty risk.

Methods of Commodity Exposure

• ETPs (ETFs or ETNs) allow investors limited to equity shares to invest in commodities.
• ETFs invest in commodities or commodity futures and track prices or indexes.
• Managed futures funds (CTAs) are actively managed, focusing on specific or diverse sectors.
• Managed futures funds can be limited partnerships or mutual funds, offering different accessibility and liquidity.
• SMAs are for larger investors needing custom portfolios.

Commodity Valuation

• Wheat today differs from wheat in six months due to storage costs and immediate usability.
• Formula: futures price ≈ spot price × (1 + risk-free rate) + storage costs - convenience yield
• Convenience yield is the nonmonetary value of having a physical commodity for use over the futures contract period.
• Contango occurs when futures prices are higher than spot prices due to low convenience yield.
• Backwardation occurs when futures prices are lower than spot prices due to high convenience yield.
• Contango decreases returns for long-only investors, while backwardation increases them.

Commodity Prices and Investments

• Spot prices are a function of supply and demand.
• Demand is affected by the value of the commodity to end users and global economic conditions.
• Supply is affected by production, storage costs, and existing inventories.
• Supply is inelastic in the short run due to long lead times.
• Commodity prices can be volatile due to demand changes or supply shocks.
• Weather and plant disease affect agricultural commodity production.
• Costs of extracting oil and minerals increase with difficult methods or locations.
• Commodity producers analyze economic events, government policy, and supply forecasts.
• Investors analyze inventory levels, production forecasts, policy changes, and economic growth expectations.
• Commodity returns and volatility have been higher than global stocks or bonds in recent decades.
• Timberland and farmland have higher average returns but lower volatility than global stocks, similar to global bonds.
• Speculators can earn high returns with accurate expectations about short-term commodity price movements.
• Commodity returns have historically low correlations with global equities and bonds.
• Adding commodities to a traditional portfolio provides diversification benefits.
• Holding commodities can hedge inflation risk.
• Commodities outperform (underperform) stocks and bonds during high (low) inflation.
• Commodity prices are more sensitive to geopolitical and weather-related risk factors.