By Dominik Poiger, Portfolio Manager at VanEck.
Dominik Poiger, Portfolio Manager at VanEck.
Why invest in hard assets?
Although commodities and natural resource equities—often referred to collectively as “hard assets”—are valued quite differently from one another on a fundamental basis, they both serve an important role as the foundation of industrial economies and can also provide similar core investment benefits.
Hard assets are typically grouped into five categories: energy (oil and gas), agriculture (grains, livestock, sugar, etc.), base metals (copper and aluminum), precious metals (gold, silver, and platinum), and forest products (paper and lumber).
Representing the essential raw materials that are used in the production of other goods and services, commodities and related natural resource equities offer investors access to global growth, inflation protection, and portfolio diversification.
Since their performance drivers are largely distinct from those of US equities, hard assets can react somewhat differently to changing market conditions, which contributes to their diversification benefits.
During periods of low inflation and low global growth, hard assets have tended to underperform US stocks and bonds. Conversely, hard assets tend to outperform stocks and bonds as the global economy heats up, exhibiting medium-to-high inflation and growth. Hard assets also tend to outperform US stocks in rising interest rate environments.
Global economic growth: the hard assets opportunity
The World Bank recently announced predictions of robust global growth of 3.1% for 2018, indicating a beneficial picture for hard assets as global growth picks up. Although recent fears of a trade war may have temporarily slowed the rise in commodity prices, increasing global growth has already fueled near-term historic highs in the consumption of commodities such as oil, copper, and zinc.
And after nearly a decade of holding interest rates at historic lows, central banks throughout the world—including the US Federal Reserve, The Bank of Mexico, and The Bank of England — are moving to contain overheating markets by raising interest rates, another potential tailwind for hard assets.
As the global economy heats up, rising inflation can become a concern for investors, which is another area where hard assets can prove beneficial. Investors who add hard assets to their portfolios can benefit from some measure of risk mitigation through portfolio diversification, as well as a counterbalance against inflation.
Constrained supply: price support for hard assets
Even as global growth is expanding, the energy and mining sectors are undergoing a paradigm shift. Following years of tremendous capital expenditures devoted to exploring, discovering, and developing new resources, energy and mining companies throughout the world have shifted their focus towards reducing costs, generating free cash flow, and returning capital to shareholders.
As a consequence, supply has tightened in some hard asset categories, boosting commodity prices. With these diminished capital expenditures in mind, it may prove challenging to sustain future supplies without new discoveries, and especially in the context of declining ore grade deposits and oil reserves. Over the long term, this could have a substantial positive effect on commodity prices.
Commodities and electric vehicles
While it may seem natural to speculate that the increasing adoption of electric vehicles could have a negative effect on commodities such as oil over the long term, this point of view ignores the other important hard assets that serve as inputs for electric cars. For example, the emerging trend in electric vehicles has already pushed up the price of nickel, an important industrial metal, to nearly four-year highs. Moreover, although it will look little like what exists today for gasoline-powered vehicles, electric vehicles will still require a similarly extensive energy infrastructure system in the years to come.
Conclusion
Global, synchronized growth, rising interest rates, and a tightening supply in commodities and natural resources may provide ongoing tailwinds for hard assets. By adding these important asset classes to their portfolios, investors can tap into global growth while mitigating some of the effects of inflation.
(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)