In a recent conversation with investor, market historian, and environmentalist Jeremy Grantham, we discussed the topic of investing in natural resources. Grantham is no fan of fossil fuels because of their link to climate change, but he sees natural-resources exposure, which can be captured through commodities futures and equities, as an important portfolio component. He mentioned their growth potential as a result of the energy transition and their diversification benefits.
Grantham’s remarks inspired me to take a fresh look at the equities-based Morningstar Global Upstream Natural Resources Index. Launched in 2011, it tracks the performance of companies that have “significant business operations in the ownership, management, and/or production of natural resources in energy, agriculture, precious or industrial metals, timber, and water resources.” Think miners, drillers, and harvesters who make money when commodities prices are going up.
What can the index’s history tell us about natural-resources investing? Whether through stocks or futures, commodities are not for the faint of heart. Prices are volatile and unpredictable. But there are good reasons for investors to consider a natural-resources allocation within a diversified portfolio.
Natural-Resources Investing: A Quick Primer
Like most Chicagoans, I have a passing familiarity with commodities futures markets. They’re not just about Midwestern farmers hedging pork bellies, though. Exchanges around the world trade agricultural products, energy, metals, and more. With their origins in ancient times, commodities futures were apparently formalized in 18th-century Japan and allowed samurais to swap rice for cash.
Speculation, in addition to hedging, is a big part of the commodities futures game. Images of colorfully clad traders bursting blood vessels spring to mind. “Colorful” also describes some episodes in commodities trading, including the case of the Hunt Brothers cornering the silver market, the Sumitomo Copper Affair, Enron’s disruption of California’s energy supply, the London Metal Exchange nickel crisis, and the manipulation of frozen concentrated orange juice futures. (Full disclosure: The last one was fictional and might be lost on readers unfamiliar with 1980s cinema and/or Eddie Murphy movies.)
Beyond scandals, futures investing holds unique risks. “Negative roll yield” refers to the complexities involved with moving from expiring futures contracts into costlier new ones. It can cause investors holding commodities futures to underperform commodities’ spot prices.
Buying stocks linked to natural resources, which include but aren’t limited to those traded on commodities markets, circumvents some of the pitfalls of futures investing. At the end of the day, they are equities, which come with both pros and cons. Benefits include liquidity, tax efficiency, capital appreciation, and dividend income. The Morningstar Global Upstream Natural Resources Index, which tracks the shares of publicly listed commodities-related businesses, covers five areas: energy, agriculture, metals, timber, and water. “Upstream” refers to the extraction node of the supply chain, which is most sensitive to commodities prices. “Downstream” companies, on the other hand, are the refiners, processors, packagers, and distributors. They are often “takers” of commodities prices.
Resources investing, whether done through futures or equities, is a tricky business. According to Grantham “[I]n anything that looks faintly like a commodity, you are going to have moments of incredible pain and regret. And you have to play for the long term because commodities … [are] not conducive to short-term guarantees. That’s why incidentally, they’re always cheap because it’s so unbelievably unpredictable.”
What’s the Point of Investing in Natural Resources?
Investors looking at the performance of commodities-oriented investments can be forgiven for giving them a hard pass. The Morningstar Global Upstream Natural Resources Index was actually in negative territory in 2024, while the broad global equity market was up roughly 17%. Commodities investments as a group have underperformed badly going back 15 years now.
There have been a couple of bright spots, though, most notably 2022. That was the year inflation moved from “transitory” to “stubborn,” and the Federal Reserve and other global central banks jacked up interest rates in response. Both stocks and bonds plunged. The talk that year was the “death of diversification” and “end of the 60/40 portfolio.”
While stocks and bonds conducted a synchronized swan dive in 2022, commodities prices soared. Russia’s invasion of Ukraine disrupted energy and grain markets, exacerbating the pandemic’s effect on supply chains. The price of Brent crude oil nearly hit $139 per barrel in March. Timber benefited from housing demand and metal prices soared. The Morningstar Global Upstream Natural Resources Index gained more than 15% in 2022, while both the Morningstar Global Markets Index and Morningstar Global Core Bond Index fell more than 17%.
This was not the first time that resources-related investments performed well when stock/bond diversification broke down. According to Morningstar’s 2024 Diversification Landscape report, inflation and rising interest rates increase the correlation between the two major asset classes. Meanwhile, “commodities themselves are a major part of most inflation indexes, so it makes sense that their prices tend to rise when inflation is increasing,” according to the report.
As an economist would say, rising commodities prices are cost drivers for most companies but revenue drivers for their producers. In the words of Grantham, “It [a natural-resources-related investment] tends to go up when the balance of your portfolio is going down. And you can see why. If you have to pay a massive increase for your metals and your oil and your raw materials and your food, of course, that’s a drain on the balance of the economy.”
The experience of 2022 caught many investors off guard. Inflation had not been a real problem for most developed markets for a generation. From 1973 through 1981, inflation averaged 9.2% per year in the US, and real returns for both stocks and bonds were negative. Meanwhile, natural-resources–based investments, including gold, were the best-performing asset class over that span. Commodities shone again during an inflationary flare-up from 1988-91.
When I started at Morningstar in 2004, natural resources were a growth investment. China’s economic boom set off a “commodities supercycle.” The Morningstar Global Upstream Natural Resources Index wasn’t launched till 2011, but its before-inception returns were stellar. Between 2003 and 2007, the index nearly quadrupled in value, while global equities gained just 144% overall. China could not get enough iron ore and other minerals to feed its growth machine.
Resources investing hasn’t been as fruitful in the years following the 2007-09 financial crisis. Global growth was sluggish for years. China slowed. US shale oil production contributed to an energy supply glut. A strong US dollar has made commodities more expensive for most of the world, which has reduced demand. Meanwhile, technology themes have dominated equity markets.
Reasons to Maintain Natural-Resources Exposure
Hedging inflation is an important function of natural-resources investing. While the US inflation rate has come down from 9%, “the specter of inflation is again looming over the markets,” in the words of Morningstar’s Sarah Hansen. Deficit spending, tariffs, geopolitics, natural disasters, and labor shortages are among the inflation drivers commonly cited. Even at 3% per year, inflation can seriously erode purchasing power. Only the bold would predict we’ve seen the last of inflation for another 30 years.
Interestingly, the price of gold surged in 2024. It could have been inflation fears, or it could be just plain fear. Gold has served as a store of value for millennia.
On the more hopeful side, there’s the energy transition. Whatever your politics, it’s just a fact that renewables are gaining traction. Some might be surprised to hear that Texas is a leader in wind and solar. Copper, nickel, lithium, and cobalt are among the “green metals” required for wind turbines, solar panels, electric vehicles, and storage. Nuclear energy, which some see as a clean energy solution, requires uranium. Meanwhile, growth in emerging markets is an argument for increased agricultural demand.
Diversification is perhaps a stronger argument than growth. It’s true that equities related to natural resources are part of major indexes and are owned by anyone with a market portfolio. But the complexion of global stock markets has changed profoundly in recent years. The energy sector was more than 11% of the Morningstar Global Markets Index’s weight in 2010; today it’s below 4%. Technology, for its part, has grown to almost a 25% weight today. In the US, technology represents more than 30% of the market. The dominant investment themes since the global financial crisis have been tech-related: mobile, cloud computing, artificial intelligence, and so on. Many investor portfolios these days are heavy on US large-cap growth stocks. Exposure to natural-resources-related businesses has likely fallen.
Few predict a return to 1970s-style inflation. A commodities supercycle akin to the early 2000s is doubtful. But natural resources could be a beneficial portfolio hedge. In the words of Morningstar’s Diversification Landscape:
“Given their low correlations with most other asset classes, commodities often stand out as portfolio diversifiers, particularly during bouts of extreme market stress. While long-term returns relative to other broad asset classes haven’t been that compelling, commodities can excel during certain market environments.”
Morningstar’s 2024 Diversification Landscape
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
