Why Every Portfolio Needs a Natural Resource Hedge

While the prospects of profiting off of energy by owning either stocks or oil futures may be uncertain in the short to intermediate-term economy, there are two compelling arguments that I want to present to encourage every investor to hold a portion of their portfolio in a Natural Resources fund. My first case is based on the global supply and demand outlook for energy over the long-term.

My second argument (which will be forthcoming in my next article) demonstrates statistically the result of adding a Natural Resource fund to one’s portfolio. I also intend to recommend some funds next article that I feel have done the best job of outperforming their peers.
First, I’d like to analyze the current pullback in energy because there have been some analysts out there wringing their hands and portending a bubble bursting in energy. Over the past couple months, oil prices have fallen from a July 13th high of $78 a barrel to current levels of about $63.50, which is a roughly a 18.5% drop. I feel that this is a healthy correction in a much longer bull run. The impetus for this correction comes from several factors. First, we’ve been fortunate on the supply side. Our hurricane season was mild and didn’t disrupt drilling in the Gulf this season. Chevron managed to make a recent massive discovery of oil reserves recently in the Gulf. Also, geopolitical tensions are easing with respect to Iran, which reduces the risk that military conflict could cause middle-east supply disruptions. To cap it off, OPEC agreed not to cut quotas at their September 12th meeting.
On the other side of the economic picture, there is some evidence that demand is easing. US growth has been slowing which provides some breathing room. Significantly, the International Energy Agency has revised downwards its projections of demand growth for the rest of 2006 and throughout 2007 (albeit not by much). As a result, I believe that the next 12-18 months will be spent forming a base around the $55-$65 a barrel range.
Now for the longer-term picture, which forecasts no end in sight to the robust growth in demand. The International Energy Agency believes oil demand will grow at a 1.6% annual rate, which translates into a 50% increase in world demand by 2030. And with the large amount of capital it takes to discover and develop new reserves, it is likely that the investment into new supplies will only barely outpace demand growth. This will cause a continuance of the extremely tight supply-demand picture that we’ve been seeing lately. When supply is tight, events that may only impact 1-2% of supply, such as hurricanes or political tensions, cause large price spikes and augmented profits.
Lately it’s been clear that much of the new demand will be found in the large developing economies such as India and China. India’s demand for oil grew at 5% this most recent quarter (year over year), and China’s demand grew at a whopping 11%. But this is just the beginning of the cycle of growth for energy in these markets. Current per capita consumption averages 1.7 barrels a year in India and China. Compare this to the 7 barrels per capita in Mexico, the 17 in Japan, and the 28 in the United States, and you’ll see how much further growth the next several decades are likely to produce. I believe that India and particularly China are going to have painful setbacks and recessions as their economies grow (my views on China’s bubble will have to wait for another time), but over the long-term their economies will grow and their demand for oil will follow suit.
As a long-term hold, a fund comprised of Natural Resource stocks should be a prudent addition to your portfolio based on the global outlook of the next few decades. If you wait, you may be able to pick up a fund at a lower price. However, the uncertainty of the current short and intermediate-term environment may cause you to miss this pullback. My next article, will shed considerable light on the use of a Natural Resources fund as a portfolio hedge.
Written By: Andy Robinson
Source: The Commodity Investor


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