Improved technology and new discoveries have allowed mining and exploration companies to extract greater quantities of raw materials from the earth more quickly and efficiently than ever before. The spike in oil prices over 2004-2008 also attracted the attention of many reluctant investors, but some are not qualified to invest in working interests, drilling partnerships or other high-risk ventures, and lack the capital necessary to purchase royalty interests.

Natural resource funds provide diversified exposure to a large segment of the economy, and often with less risk to investors than direct participation programs. This article will examine the nature and composition of these funds, as well as the type of investor for whom they are appropriate. (To read more on this topic, check out Personalizing Risk Tolerance.)

What Is a Natural Resources Fund?
Natural resources funds are funds that invest in the stocks of companies that are in the business of extracting, developing, refining and processing raw materials of any kind. Although this primarily pertains to energy and fossil fuel companies, it also includes timber and forestry, and alternative sources of energy, as well as other ores and minerals. Companies that provide technology, equipment and other related goods and services can be included here as well.

Sometimes this sector includes precious metals, even though they also have their own classification. The vast majority of natural resource funds also tend to invest almost exclusively in stocks, either domestically or globally. Many of these funds fall into the growth category in the Morningstar style box, although value and blended funds exist as well. Funds of all market capitalization ranges exist within these parameters. (To learn more, check out Build A Model Portfolio With Style Investing.)

Historical Performance
Like real estate funds, natural resource funds tend to follow their own cyclical paths, and have a relatively low correlation with the overall market. The performance of natural resource funds is most affected by major discoveries of deposits of any kind of mineral or fuel being searched for. This sector has been buoyed in the 2000s by the spike in oil prices and rising prices for gold and other metals.

According toFundAlarm, the natural resource sector was the best-performing sector of Morningstar's eight specialty categories in a five-year period ending in 2008. The average annual total return of the natural resource sector for the five-year period ending on July 31, 2008, was a whopping 27%.

Advantages and Disadvantages of Natural Resources Funds
Most energy analysts agree that 2004 represents the start of an extended long-term period of growth in the oil and gas industry. Explosive industrial growth in China and Pacific Rim countries has fueled a rising demand for oil that the world has had to scramble to meet in some respects. This increase in demand is also coming at a time when some of the traditional major oil fields in Saudi Arabia and other countries in the Middle East approach depletion. Historically, the worldwide demand for oil has doubled approximately every 10 years, and this pattern shows few signs of slowing. (To read more, check out Peak Oil: Problems and Possibilities.)

Major improvements in drilling technology have also reduced the environmental impact of traditional drilling. New seismic imaging sensors can pinpoint where oil is located underground with much greater accuracy than was possible just a decade ago. In the 1970s, large-scale drilling ventures required that enormous holes be dug into the earth in order to be successful, but only a small fraction of the same amount of ground must now be disturbed in order to achieve the same results.

Who Should Invest in a Natural Resource Fund?
Investors seeking long-term growth outside the mainstream markets should consider natural resource funds. Those who want professional management and diversification in this sector will look to these funds as primary vehicles.

The Bottom Line
Natural resources funds offer investors yet another avenue of long-term growth outside the broader markets. Although performance in 2009 and beyond may be more sedate than in preceding decades, these funds are still likely to post solid gains over time.

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